##### Table of Contents

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United States

Securities and Exchange Commission

Washington, D.C. 20549



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Form 10-KSB



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ANNUAL REPORT UNDER SECTION 13 OR
15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934



For the fiscal year ended December 31, 2004



Commission file number: 0-30541



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Pioneer Bankshares, Inc.

(Name of Small Business Issuer in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Virginia                                                       |  | 54-1278721                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



263 East Main
Street, P. O. Box 10, Stanley, Virginia 22851

(Address of principal executive office)



Issuers telephone number: (540) 778-2294



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Securities registered under Section 12(b) of the Act:

None



Securities registered under Section 12(g) of the Act

Common Stock - $.50 Par Value



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Check whether the issuer: (1) filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No ̈



Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.    Yes  x    No ̈



Issuers revenues for its most recent fiscal year were $9,026,000.



The aggregate market value of the voting stock held by
non-affiliates based on the last reported sales price of $18.10 per share as of March 17, 2005, was $16,346,762.



The number of shares outstanding of the registrants common stock, was 1,034,045 as of March 23, 2005.



DOCUMENTS INCORPORATED BY REFERENCE:



Portions of the registrants definitive Proxy Statement for its Annual Meeting of
Shareholders to be held on May 19, 2005 are incorporated by reference into Part III of this Form 10-KSB.



TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT    YES ̈NO  x



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##### Table of Contents

Securities and Exchange Commission



Washington, D.C. 20549



Form 10-KSB



TABLE OF CONTENTS



|           |  |                                                                                                                  |  |     
|---------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                                  |  | Page
|PART I     |  |                                                                                                                  |  |     
|           |  |                                                                                                                 
|Item 1.    |  | Description of Business.                                                                                         |  | 3   
|           |  |                                                                                                                 
|Item 2.    |  | Description of Property.                                                                                         |  | 9   
|           |  |                                                                                                                 
|Item 3.    |  | Legal Proceedings.                                                                                               |  | 9   
|           |  |                                                                                                                 
|Item 4.    |  | Submission of Matters to a Vote of Security Holders.                                                             |  | 9   
|           |  |                                                                                                                 
|PART II    |  |                                                                                                                  |  |     
|           |  |                                                                                                                 
|Item 5.    |  | Market for Common Equity and Related Stockholder Matters.                                                        |  | 10  
|           |  |                                                                                                                 
|Item 6.    |  | Managements Discussion and Analysis or Plan of Operations.                                                      |  | 10  
|           |  |                                                                                                                 
|Item 7.    |  | Financial Statements.                                                                                            |  | 28  
|           |  |                                                                                                                 
|Item 8.    |  | Changes In and Disagreements With Accountants On Accounting and Financial Disclosure.                            |  | 57  
|           |  |                                                                                                                 
|Item 8A.   |  | Controls and Procedures.                                                                                         |  | 57  
|           |  |                                                                                                                 
|Item 8B.   |  | Other Information.                                                                                               |  | 57  
|           |  |                                                                                                                 
|PART III   |  |                                                                                                                  |  |     
|           |  |                                                                                                                 
|Item 9.    |  | Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act. |  | 57  
|           |  |                                                                                                                 
|Item 10.   |  | Executive Compensation.                                                                                          |  | 58  
|           |  |                                                                                                                 
|Item 11.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.                  |  | 58  
|           |  |                                                                                                                 
|Item 12.   |  | Certain Relationships and Related Transactions.                                                                  |  | 58  
|           |  |                                                                                                                 
|Item 13.   |  | Exhibits.                                                                                                        |  | 59  
|           |  |                                                                                                                 
|Item 14.   |  | Principal Accountant Fees and Services.                                                                          |  | 59  
|           | 
|SIGNATURES |  | 60                                                                                                              



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##### Table of Contents

PART I



Item 1. Description of Business.



Overview



Pioneer Bankshares, Inc. (the Company), a
Virginia one bank holding company headquartered in Stanley, Virginia, was incorporated under the laws of the Commonwealth of Virginia on November 4, 1983. The Companys wholly-owned subsidiary, Pioneer Bank, Inc. (the Bank) was
established as a national bank in 1909. The Bank converted from a national bank to a state chartered bank, effective April 1994, and changed its name to Pioneer Bank, effective April 1999.



In October 2000, the Bank acquired Valley Finance Service, Inc.
(VFS), a small loan company located in Harrisonburg, Virginia. In January 2002, the assets of VFS were merged into the Bank and the subsidiary license for this company was dissolved. Valley Finance now operates as a division and branch
of the Bank offering consumer loan services.



Pioneer Bank also
owns and operates two subsidiaries, one of which is Pioneer Financial Services, LLC. Income received from insurance services and non-banking investment services is handled through Pioneer Financial Services, LLC. The second subsidiary owned by
Pioneer Bank is Pioneer Special Assets, LLC. This subsidiary is generally used in conjunction with certain foreclosed properties, in which there are environmental or other significant liability circumstances, of which none existed as of December 31,
2004 and 2003. Foreclosures of this type are handled directly through Pioneer Special Assets, LLC in an effort to minimize the risk of liability to the Bank.



The primary assets of the Company consist of all of the stock of the Bank, real estate holdings leased to the Bank, a portfolio of equity investment
securities, and minimal cash accounts.



The Bank is engaged in
the general commercial banking business, primarily serving the counties of Page, Greene, Rockingham and the City of Harrisionburg. The Company has recently expanded its service area to include Albermarle County and the City of Charlottesville,
Virginia, and is in the process of opening a new office in downtown Charlottesville. In addition, the close proximity and mobile nature of individuals and businesses in adjoining Virginia counties and nearby cities places these markets within the
Banks targeted trade area. The Bank also anticipates serving some individuals and businesses from other areas, including the counties surrounding Page County. The Bank offers a full range of banking and related financial services focused
primarily towards serving consumers, small to medium size commercial businesses, and the professional community. The Bank strives to serve the banking needs of its customers while developing personal, hometown relationships with them. The
Banks Directors believe that the marketing of customized banking services will enable the Bank to continue its position in the financial services marketplace in this market area.



The Bank provides consumers, professionals and small and medium size commercial businesses in its market area with
responsive and technologically advanced banking services. These services include competitively priced loans that are based on deposit relationships, easy access to the Banks decision-makers, and quick and innovative action necessary to meet a
customers banking needs. The Banks capitalization and lending limit enables it to satisfy the credit needs of a large portion of the targeted market segment. In the event there are customers whose loan requirements exceed the Banks
lending limit, the Bank will seek to arrange such loans on a participation basis with other financial institutions. The Board of Directors believes the Banks present capitalization will support substantial growth in deposits and loans.



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##### Table of Contents

Location and Market Area



The Bank currently operates full service branches in Stanley, Luray, Shenandoah, Harrisonburg, and Stanardsville, Virginia. The Bank is also in the
process of opening a new branch in Charlottesville, Virginia. The new office is expected to be operational by the end of the first quarter of 2005. Management will continue to investigate and consider other possible sites that would enable the Bank
to profitably serve its chosen market area.



The opening of
additional banking offices by the Bank requires prior regulatory approval, which takes into account a number of factors, including, among others, a determination that the Bank has capital in an amount deemed necessary to warrant additional expansion
and a finding that the public interest will be served. While the Bank plans to seek regulatory approval at the appropriate time to establish additional banking offices in various parts of the Banks market area, there can be no assurance when
or if the Bank will be able to undertake such expansion plans.



Banking
Services



The Bank accepts deposits, makes consumer and
commercial loans, issues drafts, and provides other services customarily offered by a commercial banking institution, such as business and personal checking and savings accounts, walk-up tellers, drive-in windows, and 24-hour automated teller
machines. The Bank is a member of the Federal Reserve System and deposits are insured under the Federal Deposit Insurance Act to the limits provided thereunder.



The Bank offers a full range of short-to-medium term commercial and consumer loans. Commercial loans include both secured and unsecured loans for
working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of equipment and machinery. Consumer loans generally include secured and unsecured loans for financing
automobiles, residential financing, home improvements, education, and personal investments.



The Banks lending activities are subject to a variety of lending limits imposed by state law. While differing limits apply in certain circumstances based on the type of loan or the nature of the borrower
(including the borrowers relationship to the Bank), in general the Bank is subject to a loan-to-one borrower limit of an amount equal to 15% of the Banks capital and surplus in the case of loans which are not fully secured by readily
marketable or other permissible types of collateral. The Bank voluntarily may choose to impose a policy limit on loans to a single borrower that is less than the legal lending limit. The Bank may establish relationships with correspondent banks to
sell interests or participations in loans when loan amounts exceed the Banks legal limitations or internal lending policies.



Other bank services include internet banking, ATM/Debit Cards, safe deposit boxes, issuance of cashiers checks, certain cash management services,
travelers checks, direct deposit of payroll and social security checks and automatic drafts for various accounts. The Banks Visa check cards and ATM debit cards can be used by bank customers throughout the United States. The Bank also
offers MasterCard and VISA credit card services. Additionally, the Bank offers a Bounce Protection program which provides overdraft privileges on checking accounts up to predetermined amounts, subject to overdraft fees. The Bank is also
licensed to sell property/casualty and life/health insurance, and investment securities, and does so through its investment subsidiary, Pioneer Financial Services, LLC.



The Bank does not have trust powers and the Bank does not anticipate obtaining trust powers. If the Bank decided to
establish a trust department in the future, the Bank could not do so without the prior approval of the Virginia State Corporation Commission. In the interim, the Bank may contract for the provision of trust services to its customers through outside
vendors.



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Competition



The banking business is highly competitive. The Bank competes as a financial intermediary with other commercial banks, savings and loan associations,
credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in the western Virginia market area and elsewhere.



The Banks market area is a also highly competitive, highly branched
banking market. Competition in the market area for loans to small to medium size businesses and individuals, the Banks target market, is intense, and pricing is important. Most of the Banks competitors have substantially greater
resources and lending limits than the Bank and offer certain services, such as extensive and established branch networks, that the Bank does not expect to provide or will not provide in the near future. Moreover, larger institutions operating in the
western Virginia market area have access to borrowed funds at a lower cost than are available to the Bank. Also, deposit competition among institutions in the market area is strong.



Employees



As of December 31, 2004, the Company had 61 employees, with 58 full-time equivalent employees. None of the employees are represented by any collective
bargaining agreements and relations with employees are considered excellent.



Supervision and Regulation



Set forth below is
a summary of statutes and regulations affecting the Company and the Bank. Federal and state laws and regulations provide regulatory oversight for virtually all aspects of both of their operations. This summary is qualified in its entirety by
reference to these statutes and regulations.



General



The Company is a bank holding company within the meaning of the Bank Holding
Company Act of 1956, and is supervised and subject to examination by the Board of Governors of the Federal Reserve System (the Federal Reserve). The Company and the Bank are also subject to Virginia laws that regulate banks and bank
holding companies. Virginias banking laws are administered by the Bureau of Financial Institutions of the Virginia State Corporation Commission (the Commission). The Company and the Bank are also affected by rules and regulations
of the Federal Deposit Insurance Corporation (the FDIC). The various laws and regulations administered by all of these regulatory agencies affect corporate practices, expansion of business, and provisions of services. Also, monetary and
fiscal policies of the United States directly affect bank loans and deposits and may affect our earnings. The future impact of these policies and of continuing regulatory changes in the financial services industry cannot be predicted. The
supervision, regulation and examination of the Bank are intended primarily for the protection of depositors rather than our stockholders.



Supervision and Regulation of the Company



As a bank holding company, the institution is required to file with the Federal Reserve periodic reports and any additional information the Federal
Reserve may require. The Company also must provide the Commission with information regarding itself and the Bank. The Federal Reserve examines the Company periodically and may examine its subsidiaries. The Commission also may examine the Company.



A bank holding company is required to obtain prior approval
from the Federal Reserve before acquiring control of substantially all the assets of any non-affiliated bank or more than 5% of the voting shares of any bank it does not already own, or before it merges or consolidates with another institution or
engages in any business other than banking or managing, controlling or furnishing services to banks and other subsidiaries, and a limited list of activities closely related to or incidental to banking. Similarly, approval of the Virginia Bureau of
Financial Institutions is required for certain acquisitions of other banks and bank holding companies.



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The Federal Reserve will approve the ownership by a bank holding company of shares in a company engaged
in activities determined by order or regulation to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. In other words, regulatory involvement, and frequently approval, is required for the Company
to engage in non-banking activities.



The Company would be
compelled by the Federal Reserve to invest additional capital in the event the Bank experiences either significant loan losses or rapid growth of loans or deposits. The Federal Reserve requires a bank holding company to act as a source of financial
strength and to take measures to preserve and protect its bank subsidiaries.



Company Capital Guidelines.The Company operates under the capital adequacy guidelines established by the Federal Reserve. Under the Federal Reserves current risk-based capital guidelines for bank holding
companies, the minimum required ratio for total capital to risk weighted assets the Company is required to maintain is 8%, with at least 4% consisting of Tier 1 capital. Tier 1 capital consists of common and qualifying preferred stock, certain other
qualifying instruments, and minority interests in equity accounts of consolidated subsidiaries, less goodwill and other intangible assets. These risk-based capital guidelines establish minimum standards, and bank holding companies generally are
expected to operate well above the minimum standards.



Financial Modernization Legislation.A bank holding company generally is restricted to activities related or incidental to banking. In the past, bank holding companies were specifically prohibited from engaging in the issue,
flotation, underwriting, public sale, or distribution of third party securities. Limits also were placed on underwriting and selling insurance. The permitted activities with respect to bank holding companies and their affiliates were substantially
expanded by the Gramm-Leach-Bliley Act, which became effective in March 2000. This act repealed the banking/securities industry anti-affiliation rules and permits the common ownership of commercial banks, investment banks, and insurance companies
under the structure of a financial holding company. Under this law, a bank holding company can elect to be treated as a financial holding company, which may engage in any activity that the Federal Reserve determines is financial in nature. A
financial holding company also may engage in any activity that is complementary to a financial activity and does not pose a substantial risk to the safety and soundness of the related depository institutions or the financial system generally.



In order for a bank holding company to qualify as a financial
holding company, all of its depository subsidiaries (i.e., banks and thrifts) must be well capitalized and well managed, and must meet their Community Reinvestment Act, or CRA, obligations, as explained below. The bank holding company also
must declare its intention to become a financial holding company to the Federal Reserve and certify that it meets the requirements. Banks and thrifts acquired by a financial holding company within 12 months prior to the date on which the election is
filed may be excluded from this test if they have less than a satisfactory CRA rating, but they must submit a plan to the applicable federal banking agency describing how the CRA rating will be brought into conformance.



The act also establishes a system of functional regulation for financial
holding companies and banks providing regulation of securities by the Securities and Exchange Commission and state securities regulators, regulation of futures by the Commodity Futures Trading Commission, and regulation of insurance activities by
the state insurance regulators. Banks may sell title insurance only when specifically permitted under applicable state law.



The Company does not currently intend to become a financial holding company under the terms of this law, but may consider doing so at some
point in the future. It is impossible to predict the impact of this new law on our competition or our operations at this time.



Securities. The Company must also comply with the requirements of the Securities Exchange Act of 1934, which include the filing of annual,
quarterly and other reports with the Securities and Exchange Commission.



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##### Table of Contents

Supervision and Regulation of the Bank



General.The Bank is a state chartered bank and member of the Federal Reserve System. The Federal Reserve and the
Commission regulate and monitor all significant aspects of the Banks operations. The Federal Reserve requires quarterly reports on the Banks financial condition, and both federal and state regulators conduct periodic examinations of the
Bank. The cost of complying with these regulations and reporting requirements can be significant. In addition, some of these regulations impact investors directly. For example, the Bank may pay dividends only out of its net undivided profits after
deducting expenses, bad debts, losses, interest and taxes accrued, and contribution to capital necessary for the Banks original capital to be restored. The Federal Reserve recommends that banks pay dividends only if the net income available to
shareholders in the past year fully funds those dividends, and the expected rate of earnings retention is consistent with capital needs, asset quality, and overall financial condition. Regulatory restrictions on the Banks ability to pay
dividends may adversely impact the Companys ability to pay dividends to its shareholders.



The Bank is subject to various state and federal banking laws and regulations that impose specific requirements or restrictions on and provide for general
regulatory oversight with respect to virtually all aspects of operations. The Bank operates under the supervision of, and subject to regulation and examination by, the Commission and the Federal Reserve. The Bank is also subject to various statutes
and regulations administered by these agencies that govern, among other things, required reserves, investments, loans, lending limits, acquisitions of fixed assets, interest rates payable on deposits, transactions among affiliates and the Bank, the
payment of dividends, mergers and consolidations, and the establishment of branch offices. Federal and state bank regulatory agencies also have the general authority to eliminate dividends paid by insured banks if such payment is deemed to
constitute an unsafe and unsound practice. As the Banks primary federal regulator, the Federal Reserve has the authority to impose penalties, initiate civil and administrative actions and take other steps to prevent the Bank from engaging in
unsafe and unsound practices.



The amount of dividends payable
by the Bank will depend upon its earnings and capital position, and is limited by federal and state law, regulations and policy. In addition, Virginia law imposes restrictions on the ability of all banks chartered under Virginia law to pay
dividends. No dividend may be declared or paid that would impair a banks paid-in capital. Both the Commission and the Federal Reserve have the general authority to limit dividends paid by the Bank if such payments are deemed to constitute an
unsafe and unsound practice.



Under current supervisory
practice, prior approval of the Federal Reserve is required if the total of all cash dividends declared in any given year will exceed the total of its net profits for such year, plus its retained net profits for the preceding two years. Also, the
Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting current losses and bad debts. For this purpose, bad debts are generally defined to include the principal amount of all loans which are in
arrears with respect to interest by six months or more, unless such loans are fully secured and in the process of collection. Federal law further provides that no issued depository institution may make any capital distribution (which would include a
cash dividend) if, after making the distribution, the institution would not satisfy one or more of its minimum capital requirements.



Capital Resources



The various federal bank regulatory agencies, including the Federal Reserve, have adopted risk-based capital requirements for assessing bank capital
adequacy. Virginia chartered banks must also satisfy the capital requirements adopted by the Commission. The federal capital standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, as
adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profile among bank holding companies and banks, to account for off-balance
sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of
total risk-weighted assets and off-balance sheet items.



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The minimum standard for the ratio of capital to risk-weighted assets (including certain off-balance
sheet obligations, such as standby letters of credit) is 8.0%. At least half of the risk-based capital must consist of common equity, retained earnings and qualifying perpetual preferred stock, less deductions for goodwill and various other
tangibles (Tier 1 capital). The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock and a limited amount of the
general valuation allowance for loan losses. The sum of Tier 1 capital and Tier 2 capital is total risk-based capital.



The Federal Reserve also has adopted regulations which supplement the risk-based guidelines to include a minimum leverage ratio of Tier 1 capital to
average total consolidated assets (Leverage ratio) of 4%. The Federal Reserve has emphasized that the foregoing standards are supervisory minimums and that a banking organization will be permitted to maintain such minimum levels of
capital only if it receives the highest rating under the regulatory rating system and the banking organization is not experiencing or anticipating significant growth. All other banking organizations are required to maintain a Leverage ratio of at
least 4.0% to 5.0% of Tier 1 capital. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and
comparable to peer group averages, without significant reliance on intangible assets. The Federal Reserve continues to consider a tangible Tier 1 leverage ratio in evaluating proposals for expansion or new activities. The tangible Tier 1
leverage ratio is the ratio of Tier 1 capital, less deductions for intangibles otherwise includable in Tier 1 capital, to total assets. The Banks capital ratios significantly exceed all requirements at December 31, 2004.



Deposit Insurance



The Banks deposits are insured by the FDIC for a maximum of $100,000 per depositor. For this protection, the Bank pays
a semi-annual statutory assessment and must comply with the rules and regulations of the FDIC. The actual assessment paid is based on the institutions assessment risk classification, which is determined based on whether the institution is
considered well capitalized, adequately capitalized or undercapitalized, as such terms have been defined in applicable federal regulations, and whether such institution is considered by its supervisory agency to
be financially sound or to have supervisory concerns. FDIC assessments can change, affecting the Banks costs, depending on the solvency of the banking industry as a whole.



In addition, the cost of complying with FDIC rules and regulations may negatively impact the Banks profitability. For
member banks like the Bank, the Federal Reserve has the authority to prevent the continuance or development of unsound and unsafe banking practices and to approve conversions, mergers and consolidations. Obtaining regulatory approval of these
transactions can be expensive, time consuming, and ultimately may not be successful.



Effect of Governmental Monetary Policies



Banking is a business that depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities
holdings, constitutes the major portion of a banks earnings. The operations of the Bank will be affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the Federal Reserve
Board regulates money, credit conditions and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of bank loans, investments and deposits, and affect
interest rates charged on loans or paid for time and savings deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to do so in the future.



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##### Table of Contents

Item 2. Description of Property.



The Companys corporate office is located in Stanley, Virginia and is directly across the street from the Banks main branch office. The building was originally built as a residence. It was purchased in 1989 and fully renovated
for commercial use. The building contains approximately 3,252 square feet.



The Banks main branch office in Stanley, Virginia was constructed in 1984, contains 12,876 square feet on three floors and is situated on approximately two acres. The building contains a full service branch,
administration and operations, bookkeeping and credit departments, three drive-through lanes and a drive-up ATM. The office is an attractive brick building with adequate room for future expansion.



The branch at Luray, Virginia is a brick building containing approximately
3,797 square feet and situated on a 200 x 150 lot. This office is a full service branch with two drive-through lanes and a walk-up ATM. This branch was built in 1989 and is located next to a shopping center. This branch is owned by the Bank.



The branch at Shenandoah is a brick building containing
approximately 3,400 square feet and situated on a 300 x 150 lot. This office is a full service branch with two drive-through lanes and a walk-up ATM. This branch was built in 1995 and is owned by the Company.



The branch in Harrisonburg, Virginia is a new brick facility, which was
constructed in 2003. The building is situated on a 130 x 190 lot, which was originally purchased in 2002. The branch contains approximately 1,620 square feet. This full-service office is located next to a shopping center and has three drive-through
lanes and a drive-up ATM.



The branch in Stanardsville,
Virginia is a double-wide modular building containing approximately 1,680 square feet and situated on .644 acre. It is equipped with two drive-through lanes and a drive-up ATM. The branch was established in 2001 and is owned by the Bank.



Valley Finance Service operates as a division/branch of Pioneer Bank and
was relocated in September 2003 from its former location of 120 S. Main Street, Harrisonburg, Virginia. This finance company and loan production office now operates out of the former branch location at 932 West Market Street, Harrisonburg, Virginia.
This facility is leased on a short-term basis at $2,013 per month. The facility is equipped with two drive-through lanes for customer convenience.



The Jenkins Building is currently a storage facility located next to the Banks main office in Stanley, Virginia. It has approximately 25,760 square
feet and was purchased on September 8, 1970. The Bank is in the process of remodeling the top floor of this building to house its data processing, technology operations, and bookkeeping departments. The construction and remodeling of this facility
began in the fall of 2004 and is expected to be completed by mid-year 2005. The total estimated costs for the renovations are approximately $1,000,000.



The new branch office location that is in the process of being established in Charlottesville, Virginia will be a leased facility at $1,650 per month.
This office will primarily offer commercial loans and small business accounts. This branch will be located at 257 Ridge McIntire Road, Charlottesville, Virginia.



Item 3. Legal Proceedings.



There
are no pending or threatened material legal proceedings to which the Company or the Bank is a party.



Item 4. Submission of Matters to a Vote of Security Holders.



Not Applicable



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##### Table of Contents

PART II



Item 5. Market for Common Equity and Related Stockholder Matters.



The Common Stock of the Company is not currently traded on any established market. The Common Stock is listed on the OTC Bulletin Board under the symbol PNBI.OB. The Banks transfer agent is Registrar
and Transfer Company, 10 Commerce Drive, Cranford Drive, Cranford, New Jersey, 07016-3572. The following table shows actual trade prices (without commissions) reported to Scott & Stringfellow, Inc. Other transactions may have occurred which were
not included in the table.



COMMON STOCK TRADE PRICES



|               |  |      |       |     |   |      
|-------------- |  | ---- | ----- | --- | - | -----
|2003           |  | High |       | Low
|First Quarter  |  | $    | 14.50 |     | $ | 11.75
|Second Quarter |  |      | 15.00 |     |   | 13.50
|Third Quarter  |  |      | 15.10 |     |   | 14.10
|Fourth Quarter |  |      | 16.60 |     |   | 15.00
|               |  |     
|2004           |  | High |       | Low
|First Quarter  |  | $    | 17.75 |     | $ | 16.07
|Second Quarter |  |      | 18.00 |     |   | 16.10
|Third Quarter  |  |      | 18.00 |     |   | 17.20
|Fourth Quarter |  |      | 18.50 |     |   | 17.15



As of March 23, 2005, there were
approximately 523 holders of record of Common Stock.



The Company has declared
dividends on its Common Stock as follows:



|               |  |            |  |             |  |                 |    
|-------------- |  | ---------- |  | ----------- |  | --------------- | ---
|Declared Date  |  | RecordDate |  | PaymentDate |  | Per ShareAmount
|3/13/03        |  | 3/18/03    |  | 3/31/03     |  | $               | .11
|6/05/03        |  | 6/16/03    |  | 6/27/03     |  |                 | .11
|9/11/03        |  | 9/16/03    |  | 9/29/03     |  |                 | .11
|12/11/03       |  | 12/22/03   |  | 12/31/03    |  |                 | .17
|               |  |            |  |             |  |                 |    
|Total for 2003 |  |            |  |             |  | $               | .50
|               |  |            |  |             |  |                 |    
|3/05/04        |  | 3/18/04    |  | 3/31/04     |  | $               | .12
|6/10/04        |  | 6/21/04    |  | 6/30/04     |  |                 | .12
|9/09/04        |  | 9/20/04    |  | 9/30/04     |  |                 | .12
|11/18/04       |  | 12/13/04   |  | 12/20/04    |  |                 | .12
|               |  |            |  |             |  |                 |    
|Total for 2004 |  |            |  |             |  | $               | .48
|               |  |            |  |             |  |                 |    



The Companys
ability to pay dividends is subject to certain restrictions imposed by the Federal Reserve and capital requirements of Federal and Virginia banking statutes and regulations. Additionally, the Company intends to follow a policy of retained earnings
sufficient for the purpose of maintaining net worth and reserves of the Bank at adequate levels and to provide for the Companys growth and ability to compete in its market area.



Item 6. Managements Discussion and Analysis or Plan of Operations.



The following is managements discussion of the financial condition and results of operations



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on a consolidated basis for the two years ended December 31, 2004 and 2003, respectively, for the Company. The consolidated financial statements of the
Company include the accounts of the Company, the Bank, and Pioneer Financial Services, LLC, and Pioneer Special Assets, LLC, each of which is a wholly-owned subsidiary of the Bank. This discussion should be read in conjunction with the audited
consolidated financial statements and related notes of the Company presented elsewhere herein.



Forward Looking Statements



The report on Form 10-KSB contains forward-looking statements with respect to the Companys and the Banks financial condition, results of operations and business. These forward-looking statements involve
certain risks and uncertainties. When used in this report of future regulatory filings, in press releases or other public shareholder communications, or in oral statements made with the approval of an authorized executive office, the words or
phrases will likely result, are expect to, will continue, is anticipated, estimate, project, believe, or similar expressions are intended to identify
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We caution the readers and users of this information not to place undue reliance on any such forward-looking statements, which speak
only as of the date made, and advise readers that various factors including regional and national economic conditions, changes in the levels of market rates of interest, credit risk and lending activities, and competitive and regulatory factors
could affect the financial performance of the Company and the Bank and could cause actual results for future periods to differ materially from those anticipated or projected.



The Company and the Bank do not undertake and specifically disclaim any obligation to publicly release the result of any
revisions, which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.



Critical Accounting Policies



General



The Companys consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our
statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when
earning income, recognizing an expense, recovering an asset, or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly
from the historical factors. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could
change.



Allowance for Loan Losses



The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basis principles of accounting: 1) Statement of Financial Accounting Standard (SFAS) No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of
occurring and estimatable and 2) SFAS114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are
observable in the market and the loan balance.



Management
evaluates the loan portfolio in light of national and local economic trends, changes in the nature and value of the portfolio and industry standards. Specific factors considered by management in determining the adequacy of the level of the allowance
include internally generated loan review reports, past due reports, historical loan loss experience and the financial condition of individual borrowers.



This review also considers concentrations of loans in terms of geography, business type and



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level of risk. Management evaluates the risk elements involved in loans relative to their collateral value and maintains the allowance for loan losses at a
level which is adequate to absorb credit losses inherent in the loan portfolio. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank
to recognize additional losses based on their judgment about information available to them at the time of their examination.



The methodology used to calculate the allowance for loan losses and the provision for loan losses is a significant accounting principle, which is based on
estimates that are particularly susceptible to significant changes in the economic environment and market conditions.



Goodwill



Goodwill is evaluated on an annual basis for impairments in value and adjusted accordingly. In June 2001, the Financial Accounting Standards Board issued
SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Additionally, it further
clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. SFAS No. 142 was effective for fiscal years beginning after December 15, 2001 and prescribes the accounting for goodwill and intangible
assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible asses with indefinite lives. Instead, these assets are subject to at least an annual impairment review, and more
frequently if certain impairment indicators are in evidence. SFAS No. 142 also requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill.



Goodwill is included in other assets and totaled $360,000 for the reporting
periods ending December 31, 2004 and 2003. Goodwill is no longer amortized, but instead is evaluated for impairment at least annually. During 2004, there was no impairment expense recognized. During 2003, the impairment expense totaled $14,000.



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OPERATIONS ANALYSIS - 2004 - Compared to 2003



Table I



PIONEER BANKSHARES, INC.

FINANCIAL
HIGHLIGHTS

(In thousands, except for per share information)



|                                                    |  |      |         |   |      |   |         |  
|--------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|Condensed Statement of Income                       |  | 2004 |         |   | 2003 |  
|Interest and dividend income                        |  | $    | 7,798   |   |      | $ | 8,172   |  
|Interest expense                                    |  |      | 1,779   |   |      |   | 2,030   |  
|                                                    |  |      |         |   |      |   |         |  
|Net interest income                                 |  |      | 6,019   |   |      |   | 6,142   |  
|Provision for loan losses                           |  |      | 72      |   |      |   | 948     |  
|                                                    |  |      |         |   |      |   |         |  
|Net interest income after provision for loan losses |  |      | 5,947   |   |      |   | 5,194   |  
|                                                    |  |     
|Noninterest income                                  |  |      | 1,188   |   |      |   | 1,474   |  
|Noninterest expense                                 |  |      | 4,781   |   |      |   | 4,721   |  
|                                                    |  |      |         |   |      |   |         |  
|Income before income taxes                          |  |      | 2,354   |   |      |   | 1,947   |  
|Income tax expense                                  |  |      | 792     |   |      |   | 633     |  
|                                                    |  |      |         |   |      |   |         |  
|Net Income                                          |  | $    | 1,562   |   |      | $ | 1,314   |  
|                                                    |  |      |         |   |      |   |         |  
|At Year End                                         |  |      |         |   |      |   |         |  
|Assets                                              |  | $    | 133,265 |   |      | $ | 120,921 |  
|Deposits                                            |  |      | 100,797 |   |      |   | 99,591  |  
|Loans, Net                                          |  |      | 92,283  |   |      |   | 80,781  |  
|Stockholders Equity                                |  |      | 13,537  |   |      |   | 13,165  |  
|                                                    |  |     
|Per Share Information                               |  |      |         |   |      |   |         |  
|Net income per share, basic                         |  | $    | 1.46    |   |      | $ | 1.20    |  
|Net income per share, diluted                       |  |      | 1.45    |   |      |   | 1.20    |  
|Dividends per share                                 |  |      | .48     |   |      |   | .50     |  
|Book value per share                                |  |      | 13.09   |   |      |   | 12.26   |  
|                                                    |  |     
|Financial Statement Ratios                          |  |      |         |   |      |   |         |  
|Return on average assets1                           |  |      | 1.26    | % |      |   | 1.10    | %
|Return on average equity1                           |  |      | 11.30   | % |      |   | 10.17   | %
|Dividend payout ratio                               |  |      | 32.97   | % |      |   | 41.55   | %
|Average equity to average asset1                    |  |      | 11.15   | % |      |   | 10.86   | %

---

|1 | Ratios are based primarily on daily average balances
|- | ----------------------------------------------------



Overview



The Companys net income for 2004 was $1.6 million as compared to $1.3 million in 2003.



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Net income increased approximately $248,000 or 18.87%. Diluted earnings per share increased from $1.20 in 2003 to $1.45 in 2004. The increase in earnings is
mainly attributed to a significant reduction in the provision for loan loss expense.



Total assets for the Company as of December 31, 2004 were $133 million compared to $121 million as of December 31, 2003. This represents total growth in assets of $12 million or 10.21%. The increase in assets is
directly related to significant growth in the Companys loan portfolio during the year. Total net loans as of December 31, 2004 were $92 million compared to total net loans of $81 million at December 31, 2003. This represents an overall
increase in the loan portfolio of $11.5 million or 14.24%. A significant portion of the increase in loans is in the category of commercial real estate, and is a result of the Companys efforts to seek small to medium sized business accounts as
a means of diversifying the portfolio.



Total liabilities for
the Company as of December 31, 2004 were $120 million, which is an increase of approximately $12 million or 11.11%. This increase is mainly in the area of borrowings from Federal Home Loan Bank of Atlanta, as management utilized the Companys
existing credit line as a means of obtaining low interest funds in support of its lending activities. Total deposits as of December 31, 2004 were $101 million compared to total deposits of $100 million at December 31, 2003.



The Companys total capital as of December 31, 2004 was $13.5 million,
which is an increase of approximately 372,000 or 2.83% from December 31, 2003. The Companys capital position remains strong and exceeds regulatory guidelines.



Management is unaware of any trends, events or uncertainties that would have a material effect on liquidity, capital
resources, or other operational activities. There are no current recommendations by regulatory authorities, which, if they were to be implemented, would have material effect on the Company.



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Table II



PIONEER BANKSHARES, INC.

NET
INTEREST MARGIN ANALYSIS

(ON A FULLY TAXABLE EQUIVALENT BASIS)

(In thousands )





|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|------------------------------------------ |  | ------- | ------- | - | -------------- | - | ----------------------- |  | ----- | ------- |  | - | -------------- | - | ----------------------- | - | ----- |  | ----- | -
|                                           |  | 2004    |         |   | 2003           |  
|                                           |  | Average |         |   | Income/Expense |   | AverageRatesEarned/Paid |  |       | Average |  |   | Income/Expense |   | AverageRatesEarned/Paid |  
|ASSETS                                     |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Loans:1                                    |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Commercial                                 |  | $       | 2,960   |   |                | $ | 224                     |  | 7.57  | %       |  | $ | 2,910          |   |                         | $ | 241   |  | 8.28  | %
|Real estate                                |  |         | 72,303  |   |                |   | 5,058                   |  | 7.00  | %       |  |   | 63,955         |   |                         |   | 4,761 |  | 7.44  | %
|Installment                                |  |         | 12,877  |   |                |   | 1,790                   |  | 13.90 | %       |  |   | 15,958         |   |                         |   | 2,354 |  | 14.75 | %
|Credit card                                |  |         | 713     |   |                |   | 152                     |  | 21.32 | %       |  |   | 802            |   |                         |   | 167   |  | 20.82 | %
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Total Loans                                |  |         | 88,853  |   |                |   | 7,224                   |  | 8.13  | %       |  |   | 83,625         |   |                         |   | 7,523 |  | 9.00  | %
|                                           |  |         |         |   |                |  
|Federal funds sold                         |  |         | 2,771   |   |                |   | 31                      |  | 1.12  | %       |  |   | 5,231          |   |                         |   | 53    |  | 1.01  | %
|Interest bearing deposits                  |  |         | 7,053   |   |                |   | 163                     |  | 2.31  | %       |  |   | 5,618          |   |                         |   | 113   |  | 2.01  | %
|Securities                                 |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Taxable                                    |  |         | 12,350  |   |                |   | 324                     |  | 2.62  | %       |  |   | 11,522         |   |                         |   | 360   |  | 3.12  | %
|Nontaxable                                 |  |         | 2,478   |   |                |   | 81                      |  | 3.27  | %       |  |   | 3,333          |   |                         |   | 181   |  | 5.43  | %
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Total Earning Assets                       |  |         | 113,505 |   |                |   | 7,823                   |  | 6.89  | %       |  |   | 109,329        |   |                         |   | 8,230 |  | 7.53  | %
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Allowance for loan losses                  |  |         | (1,436  | ) |                |   |                         |  |       |         |  |   | (1,562         | ) |                         |   |       |  |       |  
|Nonearning assets                          |  |         | 11,966  |   |                |   |                         |  |       |         |  |   | 11,190         |   |                         |   |       |  |       |  
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Total Assets                               |  | $       | 124,035 |   |                |   |                         |  |       |         |  | $ | 118,957        |   |                         |   |       |  |       |  
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|                                           |  |         |         |   |                |  
|Deposits:                                  |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Interest bearing demand deposits           |  | $       | 14,343  |   |                | $ | 55                      |  | 0.38  | %       |  | $ | 13,384         |   |                         | $ | 70    |  | 0.52  | %
|Savings                                    |  |         | 13,679  |   |                |   | 66                      |  | 0.48  | %       |  |   | 12,677         |   |                         |   | 90    |  | 0.71  | %
|Time deposits                              |  |         | 47,562  |   |                |   | 1,214                   |  | 2.55  | %       |  |   | 54,143         |   |                         |   | 1,585 |  | 2.93  | %
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Total Deposits                             |  |         | 75,584  |   |                |   | 1,335                   |  | 1.77  | %       |  |   | 80,204         |   |                         |   | 1,745 |  | 2.18  | %
|                                           |  |         |         |   |                |  
|Borrowings                                 |  |         | 10,952  |   |                |   | 444                     |  | 4.05  | %       |  |   | 4,912          |   |                         |   | 285   |  | 5.80  | %
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Total Interest Bearing Liabilities         |  |         | 86,536  |   |                |   | 1,779                   |  | 2.06  | %       |  |   | 85,116         |   |                         |   | 2,030 |  | 2.38  | %
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Noninterest bearing deposits               |  |         | 23,050  |   |                |   |                         |  |       |         |  |   | 20,250         |   |                         |   |       |  |       |  
|Other liabilities                          |  |         | 628     |   |                |   |                         |  |       |         |  |   | 667            |   |                         |   |       |  |       |  
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Total Liabilities                          |  |         | 110,214 |   |                |   |                         |  |       |         |  |   | 106,033        |   |                         |   |       |  |       |  
|                                           |  |         |         |   |                |  
|Stockholders equity                       |  |         | 13,821  |   |                |   |                         |  |       |         |  |   | 12,924         |   |                         |   |       |  |       |  
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Total Liabilities and Stockholders Equity |  | $       | 124,035 |   |                |   |                         |  |       |         |  | $ | 118,957        |   |                         |   |       |  |       |  
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Net Interest Earnings                      |  |         |         |   |                | $ | 6,044                   |  |       |         |  |   |                |   |                         | $ | 6,200 |  |       |  
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  
|Net Yield on Interest Earning Assets       |  |         |         |   |                |   |                         |  | 5.32  | %       |  |   |                |   |                         |   |       |  | 5.67  | %
|                                           |  |         |         |   |                |   |                         |  |       |         |  |   |                |   |                         |   |       |  |       |  

---

|1 | Nonaccrual loans are included in computing the average balance.
|- | ---------------------------------------------------------------

|2 | An incremental tax rate of 34% and a 70% dividend exclusion was used to calculate the tax equivalent income. The total tax equivalent adjustment was $47,000 and
$58,000 in 2004 and 2003, respectively.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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Table III



PIONEER BANKSHARES, INC.

EFFECT OF
RATE-VOLUME CHANGE ON NET INTEREST INCOME

(On a fully tax equivalent basis)

(In thousands of dollars)



|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|---------------------------------- |  | ----------------------------------------- | ---- | - | ----------------------------------------- | - | ---- | ----- |  | - | ------ | - |  | ---- | ------ | - | ----- | - | ---- | - |  | - | ------ | -
|                                   |  | 2004 Compared to 2003 Increase (Decrease) |      |   | 2003 Compared to 2002 Increase (Decrease) |  
|                                   |  | Volume                                    |      |   | Rate                                      |   |      | Total |  |   | Volume |   |  | Rate |        |   | Total |  
|Interest Income                    |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Loans                              |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Commercial                         |  | $                                         | 4    |   |                                           | $ | (21  | )     |  | $ | (17    | ) |  | $    | (4     | ) |       | $ | (3   | ) |  | $ | (7     | )
|Real estate                        |  |                                           | 621  |   |                                           |   | (324 | )     |  |   | 297    |   |  |      | (117   | ) |       |   | (367 | ) |  |   | (484   | )
|Installment                        |  |                                           | (454 | ) |                                           |   | (110 | )     |  |   | (564   | ) |  |      | (917   | ) |       |   | (31  | ) |  |   | (948   | )
|Credit Card                        |  |                                           | (19  | ) |                                           |   | 4    |       |  |   | (15    | ) |  |      | (22    | ) |       |   | (4   | ) |  |   | (26    | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Total Loans                        |  |                                           | 152  |   |                                           |   | (451 | )     |  |   | (299   | ) |  |      | (1,060 | ) |       |   | (405 | ) |  |   | (1,465 | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Federal funds sold                 |  |                                           | (25  | ) |                                           |   | 3    |       |  |   | (22    | ) |  |      | (79    | ) |       |   | (31  | ) |  |   | (110   | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Interest bearing deposits in banks |  |                                           | 29   |   |                                           |   | 21   |       |  |   | 50     |   |  |      | 18     |   |       |   | 13   |   |  |   | 31     |  
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Investments                        |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Taxable                            |  |                                           | 26   |   |                                           |   | (62  | )     |  |   | (36    | ) |  |      | 298    |   |       |   | (264 | ) |  |   | 34     |  
|Nontaxable                         |  |                                           | (46  | ) |                                           |   | (54  | )     |  |   | (100   | ) |  |      | (30    | ) |       |   | 27   |   |  |   | (3     | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Total Securities                   |  |                                           | (20  | ) |                                           |   | (116 | )     |  |   | (136   | ) |  |      | 268    |   |       |   | (237 | ) |  |   | 31     |  
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Total Earning Assets               |  | $                                         | 136  |   |                                           | $ | (543 | )     |  | $ | (407   | ) |  | $    | (853   | ) |       | $ | (660 | ) |  | $ | (1,513 | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Interest Expense                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Demand deposits                    |  | $                                         | 5    |   |                                           | $ | (20  | )     |  | $ | (15    | ) |  | $    | 13     |   |       | $ | (51  | ) |  | $ | (38    | )
|Savings                            |  |                                           | 7    |   |                                           |   | (31  | )     |  |   | (24    | ) |  |      | 12     |   |       |   | (48  | ) |  |   | (36    | )
|Time deposits                      |  |                                           | (193 | ) |                                           |   | (178 | )     |  |   | (371   | ) |  |      | (364   | ) |       |   | (739 | ) |  |   | (1,103 | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Total Deposits                     |  |                                           | (181 | ) |                                           |   | (229 | )     |  |   | (410   | ) |  |      | (339   | ) |       |   | (838 | ) |  |   | (1,177 | )
|                                   |  |                                           |      |   |                                           |  
|Borrowings                         |  |                                           | 350  |   |                                           |   | (191 | )     |  |   | 159    |   |  |      | (33    | ) |       |   | (3   | ) |  |   | (36    | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Total Liabilities                  |  |                                           | 169  |   |                                           |   | (420 | )     |  |   | (251   | ) |  |      | (372   | ) |       |   | (841 | ) |  |   | (1,213 | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Net Interest Earnings              |  | $                                         | (33  | ) |                                           | $ | (123 | )     |  | $ | (156   | ) |  | $    | (481   | ) |       | $ | 181  |   |  | $ | (300   | )
|                                   |  |                                           |      |   |                                           |   |      |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  



Note: Volume changes have been
determined by multiplying the prior years average rate by the change in average balances outstanding. The rate change is the difference between the total change and the volume change.



16



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##### Table of Contents

Net Interest Income



Net interest income decreased $123,000 or 2.00% in 2004 compared to a decrease of $298,000 or 4.63% for 2003. The decrease
in net interest income for 2004 is a result of a large volume lending in the commercial loan category, which have lower interest yields than the Companys previous focus on consumer installment type loans. Another factor affecting the net
interest income was the decline in interest rates over the past two years, which pushed loan pricing rates lower in order to remain competive. Interest and fees on loans decreased in 2004 by $299,000 or 3.97%, which is also directly related to the
lower yields and market interest rates. As interest rates rise and the volume of lending activities continues to grow, the Company expects that interest income will increase.



Interest income on securities held to maturity and securities available for sale decreased by $92,000 or 22.28% in 2004
compared to a increase of $28,000 in 2003. The average yields on securities decreased from 3.64% in 2003 to 2.73% in 2004. The decrease in interest income on securities is a result of managements reinvestment activities in short-term
instruments, as well as the lower reinvestment rates that have been available in the market during the past year. Management has maintained a short-term investment strategy as a means of safeguarding the investment portfolio and maintaining adequate
cash flow to support lending activities.



Interest income on
federal funds sold and other deposits was $194,000 in 2003, compared to $166,000 in 2003. This increase of $28,000 is a result of market interest rate increases during the later half of 2004 in comparision to the lower market interest rates for
2003.



The net interest margin on earning assets
on a tax equivalent basis decreased from 5.67% in 2003 to 5.32% in 2004. The lower yields on loans were the primary factor affecting the net interest margin.



Total interest expense decreased $251,000 or 12.36% in 2004. A decrease in interest expense on deposits accounted for $410,000 of the total overall
decrease. The decrease in interest expense on deposits is directly related to the decrease in the time deposit portfolio and is a result of the Companys funds management decisions. The yield on total deposit decreased from 2.18% to 1.77%.
Offsetting the deposit interest decrease was an increase of $159,000 in interest expense on borrowings. This increase is a result of additional borrowing activity as a source of funds to support loan growth.



Yields on total loans decreased from 9.00% in 2003 to 8.13% in 2004. The
yield on commercial loans decreased from 8.28% in 2003 to 7.57% in 2004. Real estate, and consumer installment loan yields have also decreased primarily due to the decrease in volume of loans in these categories, as well as interest rate reductions
in the market over the past two years.



The yield on taxable
investments decreased from 3.12% in 2003 to 2.62% in 2004. The decrease in taxable investment yields resulted from the reduced volume of investments and recent low market interest rates. The tax equivalent yield on nontaxable investments decreased
from 5.43% in 2003 to 3.27% in 2004.



The average amount
borrowed increased from $4.9 million in 2003 to $11 million in 2004. At year-end 2004, the Bank borrowed additional funds of approximately $8 million in preparation for 2005 budget needs and anticipated loan growth. Management chose to borrow these
funds at this time in order to take advantage of the low interest rate market, which will enable the Company to maximize net interest earnings going forward.



Non-interest Income and Expense



Non-interest income decreased from $1.5 million in 2003 to $1.2 million in 2004. This represents a 19.40% decrease. The factors affecting this change
were: gains on security transactions of $305,000 for 2004 compared to gains of $292,000 in 2003. The Company received $10,000 in commission income from sale of insurance and investment products in 2004 compared to $49,000 in 2003. Service charge
income accounted for approximately 68% of total non-interest income in 2004 compared to approximately 62% for 2003. This income was mostly generated from overdraft charges related to the Banks Bounce Protection program. Additionally, the
Companys total other income,



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which is comprised of multiple miscellaneous operating expense categories, decreased by $157,000 when compared to the previous year. Included in this total
for 2003 was an asset transfer transaction, which contributed approximately $79,000 in gains to the other income category. There were no comparable transactions or asset transfers during 2004.



Non-interest expense increased $60,000 (1.27%) from 2003 to 2004. Salaries
and benefits increased by $75,000 or 3.52% in 2004 compared to 2003. Equipment expenses increased $35,000 or 4.67% in 2004 compared to 2003, due to additional depreciation on new equipment and system enhancements, as well as, increased repairs and
maintenance. Total legal fees decreased by $11,000 from 2004 to 2003. Other expenses decreased by $80,000 or 5.07% as a result of the Companys proactive cost saving efforts.



General Uncertainties and Trends



Management is of the opinion that loans classified for regulatory purposes as loss, doubtful, substandard, or special mention do not (i) represent or
result from trends or uncertainties which are reasonably expected to materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits which any available information causes serious doubts as to the
ability of such borrowers to comply with the loan repayment terms.



Management is not aware of any known trends, events or uncertainties that will have or that are reasonably likely to have a material effect on the issuers liquidity, capital resources or operations of the issuers. Additionally, management
is not aware of any current recommendations by the regulatory authorities which, if they were to be implemented, would have such an effect.



Securities



Securities as of December 31, 2004 totaled $12.3 million, which is a 33% decrease over the December 31, 2003 balance of $18.3 million. This decline is the
result of reduced volume of investment activity, as funds were utilized as a source for loan growth.



Average balances in securities decreased by $27,000 in 2004. The Company maintains an adequate level of securities to provide for liquidity and as
security for public indebtedness. A schedule of securities including the carrying amount and estimated market value of securities by contractual maturity is shown in a note to the consolidated financial statements. Managements philosophy is to
keep the maturities of investments relatively short which allows the Company to better match deposit maturities with investment maturities and thus react more quickly to interest rate changes.



At December 31, 2004 the Parent Company had investments in common and
preferred stock with a cost of $1.8 million and an estimated market value of $2 million. The investments include common stocks purchased with the objective of realizing capital gains. The market value of these investments is sensitive to general
trends in the stock market.



The Banks total investment
portfolio at December 31, 2004 has a cost of $10.4 million and an estimated fair market value of $10.3 million. These investments include U.S. government and agency securities, state and municipal securities, and a small amount of held-to-maturity
mortgage-backed securities.



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##### Table of Contents

Securities (continued)



The schedule below summarizes the book value of the portfolio by maturity classification and shows the weighted average
yield in each group:



|                                               |  |                 |        |                      |       |   |                |   |                      |  |      |  
|---------------------------------------------- |  | --------------- | ------ | -------------------- | ----- | - | -------------- | - | -------------------- |  | ---- | -
|(In Thousands)                                 |  | 2004 Book Value |        | WeightedAverageYield |       |   | 2003Book Value |   | WeightedAverageYield | 
|Securities available for sale                  |  |                 |        |                      |       |   |                |   |                      |  |      |  
|Maturing within one year                       |  | $               | 1,270  |                      | 4.59  | % |                | $ |                     |  |     |  
|Maturing after one year But within five years  |  |                 | 8,808  |                      | 3.49  | % |                |   | 15,533               |  | 3.41 | %
|Maturing after five years But within ten years |  |                 | 229    |                      | 4.45  | % |                |   | 553                  |  | 4.58 | %
|Maturing after 10 years                        |  |                 |       |                      |       |   |                |   | 573                  |  | 4.54 | %
|                                               |  |                 |        |                     
|Equity Securities                              |  |                 | 2,024  |                      |       |   |                |   | 1,689                |  |      |  
|                                               |  |                 |        |                      |       |   |                |   |                      |  |      |  
|Total securities available for sale            |  | $               | 12,331 |                      | 3.65  | % |                | $ | 18,348               |  | 3.49 | %
|                                               |  |                 |        |                      |       |   |                |   |                      |  |      |  
|Securities held to maturity                    |  |                 |        |                      |       |   |                |   |                      |  |      |  
|Maturing within one year                       |  | $               |       |                      |      |   |                | $ |                     |  |     |  
|Maturing after one year But within five years  |  |                 | 15     |                      | 7.00  | % |                |   | 31                   |  | 7.24 | %
|Maturing after five but Within ten years       |  |                 | 1      |                      | 12.00 | % |                |   |                     |  |     |  
|                                               |  |                 |        |                      |       |   |                |   |                      |  |      |  
|Total securities held to maturity              |  | $               | 16     |                      | 7.30  | % |                | $ | 31                   |  | 7.24 | %
|                                               |  |                 |        |                      |       |   |                |   |                      |  |      |  
|Total Securities                               |  | $               | 12,347 |                      | 3.65  | % |                | $ | 18,379               |  | 3.50 | %
|                                               |  |                 |        |                      |       |   |                |   |                      |  |      |  



Equity securities have
been excluded from the weighted average yield calculations in the above table.



The Company accounts for investments under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. This statement requires all securities to be classified at the point of purchase
as trading securities, available for sale or held to maturity. See the notes to the financial statements for a discussion of the accounting policies for investments. The Company values its debt securities based on information supplied by its
correspondent banks for actively traded obligations and by market comparison with similar obligations for non-rated investments. Investments in common stocks are based on the last trade prices as provided by the Companys investment broker.



Loan Portfolio



Total net loans increased during 2004 from $80.8 million at December 31,
2003 to $92.3 million at December 31, 2004. This is an increase of $11.5 million or 14.24%. The increase in the loan portfolio was mainly in the area of commercial and residential real estate loans. The Bank has historically been concentrated in
consumer auto and installment loans, and management has recently taken proactive steps to diversify the portfolio by seeking small to medium sized business loans throughout its service area. The Bank continues to make consumer loans, as well as
residential mortgage loans for its customer base.



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##### Table of Contents

Loans are stated at their face amount, net of unearned discount, and are classified as follows at
December 31:



|                                  |  |                  |        |   |                  |   |        |  
|--------------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------ | -
|                                  |  | (In Thousands)   |       
|                                  |  | December 31,2004 |        |   | December 31,2003 |  
|Mortgage loans on real estate     |  |                  |        |   |                  |   |        |  
|Construction loans                |  | $                | 7,193  |   |                  | $ | 5,929  |  
|Agricultural                      |  |                  | 4,607  |   |                  |   | 4,809  |  
|Equity lines of credit            |  |                  | 1,738  |   |                  |   | 1,853  |  
|Residential 1-4 family            |  |                  | 41,125 |   |                  |   | 37,930 |  
|Second Mortgages                  |  |                  | 3,305  |   |                  |   | 2,726  |  
|Multifamily                       |  |                  | 1,853  |   |                  |   | 517    |  
|Commercial                        |  |                  | 17,046 |   |                  |   | 10,712 |  
|                                  |  |                  |        |   |                  |   |        |  
|Total real estate loans           |  |                  | 76,867 |   |                  |   | 64,476 |  
|                                  |  |                 
|Commercial and agricultural loans |  |                  | 3,548  |   |                  |   | 3,794  |  
|Consumer installment loans        |  |                  |        |   |                  |   |        |  
|Personal                          |  |                  | 13,641 |   |                  |   | 14,416 |  
|Credit cards                      |  |                  | 729    |   |                  |   | 803    |  
|                                  |  |                  |        |   |                  |   |        |  
|Total consumer installment loans  |  |                  | 14,370 |   |                  |   | 15,219 |  
|All other loans                   |  |                  | 166    |   |                  |   | 260    |  
|                                  |  |                  |        |   |                  |   |        |  
|Gross Loans                       |  |                  | 94,951 |   |                  |   | 83,749 |  
|                                  |  |                 
|Less unearned income on loans     |  |                  | (1,322 | ) |                  |   | (1,535 | )
|                                  |  |                  |        |   |                  |   |        |  
|Loans, less unearned discount     |  |                  | 93,629 |   |                  |   | 82,214 |  
|                                  |  |                 
|Less allowance for loan losses    |  |                  | (1,346 | ) |                  |   | (1,433 | )
|                                  |  |                  |        |   |                  |   |        |  
|Net Loans Receivable              |  | $                | 92,283 |   |                  | $ | 80,781 |  
|                                  |  |                  |        |   |                  |   |        |  



The Banks policy
has been to make collectible loans that are held for future interest income. Collateral required by the Bank is determined on an individual basis depending on the purpose of the loan and the financial condition of the borrower.



The Banks residential real estate loans, including equity lines of
credit and second mortgages totaled $46 million as of December 31, 2004. This represents an increase of approximately $3.7 million in the residential loan portfolio over the previous year. Residential real estate loans are generally made for a
period not to exceed 30 years and are secured by first deed of trust, which do not exceed 80% of the appraised value. If the loan to value ratio exceeds 80%, the Company requires additional collateral or guarantees. For a majority of the real estate
loans, interest is adjustable after each three or five year period. Fixed rate loans are generally made for a fifteen-year period. In addition, the Bank makes home equity loans secured by second deeds of trust with total indebtedness not to exceed
80% of the appraised value. Home equity loans are made on a 10-year revolving line of credit basis.



The Banks commercial real estate loans, including construction accounts, agricultural real estate, multifamily dwellings, and other business
properties totaled $30.7 million as of December 31, 2004. This represents an increase of approximately $8.7 million in the commercial real estate portfolio in comparison to the balance of $22.0 million as of December 31, 2003. The increase in
commercial real estate loans is a direct result of managements focus on this lending category in an effort to diversify the overall lending portfolio. Management has established specific lending criteria relating to commercial loans and considers
the risk of loss in this loan category to be relatively low.



The Banks consumer loan portfolio decreased $849,000 (5.58%) to $14.4 million at December 31, 2004. This decrease is attributed to low consumer demand, as well as managements focus on diversifying the loan portfolio with an
increased effort to attract small to medium sized business loans.



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##### Table of Contents

A schedule of remaining maturities of selected loan categories is as follows: (in thousands)



|                                             |  |                   |       |                                   |   |      
|-------------------------------------------- |  | ----------------- | ----- | --------------------------------- | - | -----
|                                             |  | ConstructionLoans |       | Commercial and Agricultural Loans
|Loans maturing within one year               |  | $                 | 3,101 |                                   | $ | 1.128
|Variable rate                                |  |                   | 1,045 |                                   |   |     
|Fixed rate, over one year through five years |  |                   | 2,713 |                                   |   | 1.845
|Fixed rate, over five years                  |  |                   | 334   |                                   |   | 575  
|                                             |  |                   |       |                                   |   |      
|Total Maturities of Selected Loans           |  | $                 | 7,193 |                                   | $ | 3,548
|                                             |  |                   |       |                                   |   |      



At December 31, 2004,
no industry category exceeded ten percent of total loans.



Risk Elements
in the Loan Portfolio



The following schedule outlines
the non-accrual, restructured, and other non-performing risk elements in the loan portfolio as of December 31, 2004 and December 31, 2003:



|                                         |  |                |       |   |      |   |      |  
|---------------------------------------- |  | -------------- | ----- | - | ---- | - | ---- | -
|                                         |  | 2004           |       |   | 2003 |  
|                                         |  | (In Thousands) |      
|Non-accrual Loans                        |  | $              | 462   |   |      | $ | 212  |  
|Loans Past Due 90 days or more           |  |                | 428   |   |      |   | 321  |  
|Other Impaired Loans                     |  |                | 429   |   |      |   | 461  |  
|                                         |  |                |       |   |      |   |      |  
|Total non-performing assets              |  | $              | 1,318 |   |      | $ | 994  |  
|                                         |  |                |       |   |      |   |      |  
|Allowance for loan losses to total loans |  |                | 1.44  | % |      |   | 1.74 | %
|                                         |  |               
|Non-performing Assets to total loans     |  |                | 1.41  | % |      |   | 1.21 | %



Non-accrual loans are
loans on which the interest accruals have been suspended or discontinued as a result of the borrowers financial difficulties and delinquency status. Interest accruals are continued on past due, secured loans until the principal and accrued
interest equal the value of the collateral and on unsecured loans until the financial condition of the creditor deteriorates to the point that any further accrued interest would be determined to be uncollectible.



Restructured loans are loans on which the original interest rate or repayment
terms have been substantially changed due to the borrowers financial hardship. There were no restructured loans on which interest was accruing at a reduced rate or on which payments had been extended.



Impaired loans are those loans which have been identified by management as
problem credits due to various circumstances concerning the borrowers financial condition and frequent delinquency status. These loans may not be delinquent to the extent that would warrant a nonaccrual classification, however, management has
classified these account as impaired and is monitoring the circumstances and payment status closely. In most cases, a specific allocation to the Banks allowance for loan loss is made for an impaired loan.



At December 31, 2004, approximately 86% of the loans that were past due 90
days or more are well secured with real estate properties. Management monitors all past due accounts carefully for any anticipated losses and makes appropriate allocations of funds for potential losses as they are identified.



Interest on non-accrual loans did not have a significant impact on income for
2004 or 2003.



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##### Table of Contents

Loan Losses and Allowance For Loan Losses



The following schedule outlines the activity in the allowance for loan loss account as of December 31, 2004 and December 31,
2003:



|                                              |  |      |       |   |      |   |       |  
|--------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                              |  | 2004 |       |   | 2003 |  
|Beginning balance                             |  | $    | 1,433 |   |      | $ | 1,448 |  
|                                              |  |     
|Provision charged to expense                  |  |      | 72    |   |      |   | 948   |  
|                                              |  |     
|Loan losses:                                  |  |      |       |   |      |   |       |  
|Commercial                                    |  |      |      |   |      |   | 36    |  
|Installment                                   |  |      | 568   |   |      |   | 1,331 |  
|Real estate                                   |  |      | 25    |   |      |   | 161   |  
|Credit card                                   |  |      | 25    |   |      |   | 55    |  
|                                              |  |      |       |   |      |   |       |  
|Total Loan Losses                             |  |      | 618   |   |      |   | 1,583 |  
|                                              |  |      |       |   |      |   |       |  
|Recoveries:                                   |  |      |       |   |      |   |       |  
|Commercial                                    |  |      |      |   |      |   |      |  
|Installment                                   |  |      | 381   |   |      |   | 612   |  
|Real estate                                   |  |      | 67    |   |      |   |      |  
|Credit card                                   |  |      | 11    |   |      |   | 8     |  
|                                              |  |      |       |   |      |   |       |  
|Total Loan Recoveries                         |  |      | 459   |   |      |   | 620   |  
|                                              |  |      |       |   |      |   |       |  
|Net Loan Losses                               |  |      | 159   |   |      |   | 963   |  
|                                              |  |      |       |   |      |   |       |  
|Balance at End of Period                      |  | $    | 1,346 |   |      | $ | 1,433 |  
|                                              |  |      |       |   |      |   |       |  
|Net Loan Losses as a Percent of Average loans |  |      | 0.18  | % |      |   | 1.15  | %



A breakdown of the
allowance allocations by loan type are presented below for December 31, 2004 and December 31, 2003:



|                                                         |  |                   |       |                     |                   |   |                          |        |   |        |   |                     |  |        |                        |  |        |  
|-------------------------------------------------------- |  | ----------------- | ----- | ------------------- | ----------------- | - | ------------------------ | ------ | - | ------ | - | ------------------- |  | ------ | ---------------------- |  | ------ | -
|                                                         |  | December 31, 2004 |       |                     | December 31, 2003 |  
|                                                         |  | Amount            |       | Percent ofAllowance |                   |   | Percent of Average Loans |        |   | Amount |   | Percent ofAllowance |  |        | Percent ofAverageLoans | 
|Analysis of Ending Balance                               |  |                   |       |                     |                   |   |                          |        |   |        |   |                     |  |        |                        |  |        |  
|Commercial                                               |  | $                 | 428   |                     | 31.80             | % |                          | 3.33   | % |        | $ | 431                 |  | 30.07  | %                      |  | 3.48   | %
|Real estate                                              |  |                   | 175   |                     | 13.00             | % |                          | 81.38  | % |        |   | 145                 |  | 10.12  | %                      |  | 76.48  | %
|Installment                                              |  |                   | 697   |                     | 51.78             | % |                          | 14.49  | % |        |   | 808                 |  | 56.39  | %                      |  | 19.08  | %
|Credit card                                              |  |                   | 46    |                     | 3.42              | % |                          | 0.80   | % |        |   | 49                  |  | 3.42   | %                      |  | 0.96   | %
|                                                         |  |                   |       |                     |                   |   |                          |        |   |        |   |                     |  |        |                        |  |        |  
|Total                                                    |  | $                 | 1,346 |                     | 100.00            | % |                          | 100.00 | % |        | $ | 1,433               |  | 100.00 | %                      |  | 100.00 | %
|                                                         |  |                   |       |                     |                   |   |                          |        |   |        |   |                     |  |        |                        |  |        |  
|Allowance for loan losses as a percent of year end loans |  |                   |       |                     | 1.44              | % |                          |        |   |        |   |                     |  | 1.74   | %                      |  |        |  



For periods presented,
the provision for loan losses charged to operations is based on managements judgment after taking into consideration all factors connected with the collectibility of the existing portfolio. Management evaluates the loan portfolio in light of
economic conditions, changes in the nature and value of the portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operations include internally generated loan review
reports, past due reports, historical loan loss experience, and individual borrowers financial conditions. This review also considers concentrations of loans in terms of geography, business type or level of risk. Management evaluates the risk
elements involved in loans relative to their collateral value and maintains the allowance for loan losses at a level which is adequate to absorb possible credit losses in the loan portfolio. In addition, regulatory agencies, as an integral part of
their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgment about information available to them at the time of their examination.



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The allowance for loan losses decreased from $1,433,000 at December 31, 2003 to $1,346,000 at December
31, 2004. Net charge offs decreased from $963,000 in 2003 to $159,000 in 2004. The provision expense related to the allowance for loan loss decreased $876,000 for 2004 compared to a decrease of $524,000 in 2003. The reduction in loan losses can be
directly attributed to managements proactive collection efforts and continuous monitoring of lending criteria.



Management believes that potential loan losses in the consumer loan portfolio are more than offset by higher than average loan yields. Management has also
concluded that the risk of loan loss in the commercial and residential real estate portfolios is expected to be minimal, as these loans are well collateralized. In summary, management is of the opinion that the allowance for loan losses is adequate
to absorb future losses that may occur in the existing loan portfolio.



Premises and Equipment



The Bank is
presently in the process of renovations to the Jenkins building, which is located next to the main branch office in Stanley, Virginia. The renovations consist of extensive remodeling to the upper floor of this facility. Upon completion, the facility
will house the Companys data processing and technology operations department, as well as the bookkeeping department. The total cost of this project is estimated to be approximately $1,000,000. As of December 31, 2004, the expenditures relating
to this project totaled $343,000.



The Company has established
a new lease contract and is in the process of opening a new office facility in the Charlottesville, Virginia area. Management is hopeful that the new Charlottesville branch will be operational during the first quarter of 2005. This new branch
facility will primarily serve as a loan production office for commercial and business accounts. The annual lease amount for this new facility is expected to be approximately $20,000 and office renovations are not expected to exceed $50,000.
Managements decision to expand into the Charlottesville and Albermarle County area of Virginia is based on potential loan growth opportunities.



The Company may also be required to purchase additional processing equipment in conjunction with the implementation of the Check Truncation Act of the
21stCentury (Check 21), which became effective October 28, 2004. This Act is expected to have an impact
on all financial institutions in the coming months by creating an electronic means of clearing checks. The estimated costs of equipment and check processing software related to Check 21 are expected to be approximately $35,000.



The Company continually monitors technological upgrades in the banking
industry, and may, from time to time, in order to achieve higher levels of internal operational efficiency, purchase new or additional equipment relating to such technologies. The Companys management sets specific budget allowances on an
annual basis, which are deemed to be adequate to cover expenditures that may arise throughout the year relating to technological upgrades or enhancements.



Deposits



The Companys total deposits as of December 31, 2004 were $100.8 million compared to $99.6 million at December 31, 2003. This increase of $1.2
million or 1.21% was primarily made up of increases in savings and demand deposit accounts. Total demand deposits totaled $41.1 million as of December 31, 2004 compared to $35.3 million at December 31, 2003. This represents an increase of $5.7
million or 16.27%. Demand deposits consist of checking accounts including standard consumer accounts, Now accounts, and Money Market accounts. The Companys demand deposits have historically remained relatively stable; however, these balances
do fluctuate with normal daily activity. Management does not anticipate any major changes in the demand deposit portfolio in the near future.



Total savings deposits as of December 31, 2004 were $14.0 million compared to $12.9 million as of December 31, 2003. This represents an increase of $1.1
million or 8.27%. The Companys savings deposits have remained consistent historically, with periodic fluctuation. These accounts consist of passbook savings accounts, statement savings accounts, and Christmas club accounts. Management does not
expect any major changes in the savings deposit portfolio in the near future.



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##### Table of Contents

Time accounts in the form of Certificates of Deposit instruments represent approximately 45.40% of the
Banks total deposits. Total time deposits as of December 31, 2004 were $45.8 million compared to total time deposits of $51.4 million at December 31, 2003. This represents a decrease of approximately 5.6 million or 10.92%. Time deposits are
classified in two major categories for FDIC Insurance purposes, as well as other accounting and regulatory purposes: 1) those time deposits with a balance greater than $100,000, and 2) those time deposits with a balance of $100,000 or less. The
Companys total time deposits greater than $100,000 have remained relatively stable with an outstanding balance of approximately $8.2 million for both reporting periods ending December 31, 2004 and 2003. Total time deposits with balances of
$100,000 or less were $37.5 million at December 31, 2004 compared to $43.1 million at December 31, 2003. Time deposits with a balance greater than $100,000 represent 18.00% of the total time deposit portfolio.



The maturity schedule as of December 31, 2004 for Certificates of deposit
over $100,000 are shown below:



|                   |  |   |      
|------------------ |  | - | -----
|Maturity           |  |  
|Less than 3 months |  | $ | 2,494
|3 to 12 months     |  |   | 2,737
|1 to 3 years       |  |   | 2,320
|Over 3 years       |  |   | 685  
|                   |  |   |      
|Total              |  | $ | 8,236
|                   |  |   |      



The Bank has
traditionally avoided brokered and large deposits believing that they were unstable and thus not desirable. This has proven to be a good strategy as the local deposit base is considered very stable and small increases in rates above the competition
have resulted in deposit gains in past years.



Long-term Debt



The Companys banking subsidiary has a line of
credit with the Federal Home Loan Bank (FHLB) of Atlanta upon which credit advances can be made up to 40% of total assets, subject to certain eligibility requirements. This represents a total credit line of approximately $53.3 million and $48.4
million as of December 31, 2004 and 2003, respectively. FHLB advances bear interest at a fixed or floating rate depending on the terms and maturity of each advance and numerous renewal options are available. These advances are secured by 1-4 family
residential mortgages. On some fixed rate advances the FHLB may convert the advanced to an indexed floating rate at some set point in time for the remainder of the term. If the advance converts to a floating rate, the Bank may pay back all or part
of the advance without a prepayment penalty. Floating rate advances may be paid back at any time without penalty.



In December 2004, the Company refinanced a portion of its outstanding debt and obtained additional borrowings in preparation for anticipated loan growth
and funding needs during 2005. The refinance portion of this debt was approximately $4 million, with new borrowings of $8 million, for a total new loan amount of $12 million. A prepayment penalty of $189,000 was paid on the refinanced debt and is
reflected in noninterest expense. Managements decision to utilize FHLB borrowings as a primary source of funds is based on the current low interest rate market and the potential for an increased interest margin going forward.



At December 31, 2004, the total fixed-rate long-term debt with FHLB totaled
$18.3 million and matures through December 30, 2009. The interest rates on the fixed-rate notes payable ranges from 2.92% to 3.92%. There were no floating-rate long-term debts outstanding for the Company as of December 31, 2004.



24



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##### Table of Contents

The contractual maturities of FHLB advances as of December 31, 2004 are as follows:



|            |  |                |       
|----------- |  | -------------- | ------
|            |  | (In Thousands)
|Due in 2005 |  | $              | 3,800 
|Due in 2006 |  |                | 3,800 
|Due in 2007 |  |                | 3,800 
|Due in 2008 |  |                | 3,800 
|Due in 2009 |  |                | 3,100 
|            |  |                |       
|            |  | $              | 18,300
|            |  |                |       



Analysis of Capital



The adequacy of the companys capital is
reviewed by management on an ongoing basis with reference to its size, composition, quality of assets and liability levels, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that
will assure adequate level of capital to support anticipated asset growth and absorb potential losses.



The Federal Reserve, Comptroller of the Currency, and the Federal Deposit Insurance Corporation have adopted capital guidelines to supplement the existing
definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital
to risk-weighted assets is 8.00%, of which at least 4.00% must be Tier 1 capital, composed of common equity, retained earnings, and a limited amount of perpetual preferred stock, less certain goodwill items. The Company is considered to be well
capitalized under the regulatory framework. Total consolidated capital as a percentage of risk-weighted assets was 16.6% at December 31, 2004. The ratio of Consolidated Tier 1 Capital to risk-weighted assets was 15.4% as of December 31 2004 compared
to 16.8% at December 31, 2003. Both of these ratios exceed regulatory capital requirements.



The following schedule shows a comparative breakdown of the Companys capital as of December 31, 2004 and December 31, 2003:



|                                             |  |                |        |   |      |   |        |  
|-------------------------------------------- |  | -------------- | ------ | - | ---- | - | ------ | -
|                                             |  | 2004           |        |   | 2003 |  
|                                             |  | (in thousands) |       
|Tier 1 capital                               |  |                |        |   |      |   |        |  
|Consolidated Risk-weighted assets            |  | $              | 85,086 |   |      | $ | 75,382 |  
|                                             |  |                |        |   |      |   |        |  
|Consolidated Tier 1 capital                  |  |                |        |   |      |   |        |  
|Common stock                                 |  | $              | 517    |   |      | $ | 537    |  
|Surplus                                      |  |                |       |   |      |   |       |  
|Retained Earnings                            |  |                | 12,918 |   |      |   | 12,464 |  
|Goodwill excluded                            |  |                | (360   | ) |      |   | (360   | )
|                                             |  |                |        |   |      |   |        |  
|Total Tier 1 capital                         |  |                | 13,075 |   |      |   | 12,641 |  
|                                             |  |               
|Consolidated Tier 2 capital                  |  |                |        |   |      |   |        |  
|Allowance for loan losses (1)                |  |                | 1,064  |   |      |   | 920    |  
|                                             |  |                |        |   |      |   |        |  
|Total risk-based capital                     |  | $              | 14,139 |   |      | $ | 13,561 |  
|                                             |  |                |        |   |      |   |        |  
|Consolidated total risk-based capital ratio  |  |                | 16.6   | % |      |   | 18.0   | %
|Consolidated Tier 1 risk-based capital ratio |  |                | 15.4   | % |      |   | 16.8   | %
|Consolidated Leverage ratio                  |  |                | 10.5   | % |      |   | 10.6   | %

---

|(1) | Limited to 1.25% of gross risk-weighted assets
|--- | ----------------------------------------------



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##### Table of Contents

Interest Sensitivity and Liquidity



The following table reflects the Companys interest sensitivity and interest rate risk position as of December 31,
2004:



|                                                |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|----------------------------------------------- |  | ----------- | ------- | - | ------------ | - | ------- | ----------- |  | - | ----------- | - |  | ------------- | ------ | - | ----- | ------ | - |  | - | -------
|(In Thousands)                                  |  | 1 - 90 Days |         |   | 91 - 365Days |   |         | 1 to 5Years |  |   | Over 5Years |   |  | NotClassified |        |   | Total
|Uses of Funds:                                  |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|                                                |  |             |         |   |              |  
|Loans                                           |  | $           | 8,491   |   |              | $ | 6,103   |             |  | $ | 35,633      |   |  | $             | 43,402 |   |       | 0      |   |  | $ | 93,629 
|Interest bearing Bank deposits                  |  |             | 7,885   |   |              |   | 600     |             |  |   | 1,995       |   |  |               | 0      |   |       | 0      |   |  |   | 10,480 
|                                                |  |             |         |   |              |  
|Investment Securities                           |  |             |        |   |              |   | 1,269   |             |  |   | 8,825       |   |  |               | 229    |   |       | 2,024  |   |  |   | 12,347 
|Restricted Stock                                |  |             |        |   |              |   |        |             |  |   |            |   |  |               |       |   |       | 1,181  |   |  |   | 1,181  
|Federal Funds Sold                              |  |             | 950     |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   | 950    
|                                                |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|Total                                           |  |             | 17,326  |   |              |   | 7,972   |             |  |   | 46,453      |   |  |               | 43,631 |   |       | 3,205  |   |  |   | 118,587
|                                                |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|Sources of Funds:                               |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|                                                |  |             |         |   |              |  
|Demand Deposits Interest bearing                |  |             | 14,890  |   |              |   |        |             |  |   |            |   |  |               |       |   |       |       |   |  |   | 14,890 
|Savings accounts                                |  |             | 13,954  |   |              |   |        |             |  |   |            |   |  |               |       |   |       |       |   |  |   | 13,954 
|Time Deposits:                                  |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|Over $100,000                                   |  |             | 2,494   |   |              |   | 2,737   |             |  |   | 3,005       |   |  |               |       |   |       |       |   |  |   | 8,236  
|Other certificates                              |  |             | 5,606   |   |              |   | 13,671  |             |  |   | 18,246      |   |  |               |       |   |       |       |   |  |   | 37,523 
|                                                |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|Total deposits                                  |  |             | 36,944  |   |              |   | 16,408  |             |  |   | 21,251      |   |  |               |       |   |       |       |   |  |   | 74,603 
|                                                |  |             |         |   |              |  
|Borrowings                                      |  |             | 1,300   |   |              |   | 2,500   |             |  |   | 14,500      |   |  |               |       |   |       |       |   |  |   | 18,300 
|                                                |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|Total                                           |  |             | 38,244  |   |              |   | 18,908  |             |  |   | 35,751      |   |  |               |       |   |       |       |   |  |   | 92,903 
|                                                |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        
|Discrete Gap                                    |  |             | (20,918 | ) |              |   | (10,936 | )           |  |   | 10,702      |   |  |               | 43,631 |   |       | 3,205  |   |  |   | 25,684 
|Cumulative Gap                                  |  |             | (20,918 | ) |              |   | (31,854 | )           |  |   | (21,152     | ) |  |               | 22,479 |   |       | 25,684 |   |  |   |        
|                                                |  |             |         |   |              |  
|Ratio of Cumulative Gap to Total Earning Assets |  |             | -17.64  | % |              |   | -26.86  | %           |  |   | -17.84      | % |  |               | 18.96  | % |       | 21.66  | % |  |   |        
|                                                |  |             |         |   |              |   |         |             |  |   |             |   |  |               |        |   |       |        |   |  |   |        



At December 31, 2004,
the Company had a negative cumulative Gap Rate Sensitivity Ratio of 26.86% for the one-year re-pricing period compared with -33.35% at December 31, 2003. This generally indicates that earnings would improve in a declining interest rate environment
as liabilities re-price more quickly than assets. Conversely, earnings would probably decrease in periods during which interest rates are increasing. Management constantly monitors the Companys interest rate risk and believes that the current
position is an acceptable risk for a growing community bank operating in a rural environment.



26



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##### Table of Contents

Liquidity represents an institutions ability to meet present and future financial obligations
through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash and due from banks, interest-bearing deposits in financial institutions, securities purchased
under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year.



Liquidity as of December 31, 2004 remains adequate. The Bank historically has had a stable core deposit base and, therefore, does not have to rely on
volatile funding sources. Because of the stable core deposit base, changes in interest rates should not have a significant effect on liquidity. The Bank was a seller of federal funds for most of 2004 and 2003. The Banks membership in the
Federal Home Loan Bank System also provides liquidity, as the Bank can borrow money that is repaid over a ten-year period and can use the money to make fixed rate loans. The matching of the long-term loans and liabilities helps the Bank reduce its
sensitivity to interest rate changes. The Bank reviews its interest rate gap periodically and makes adjustments as needed.



There are no off-balance-sheet items that should impair future liquidity.



Off-Balance Sheet Commitments



The Company enters into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of its customers. These
off-balance sheet arrangements include commitments to extend credit, standby letters of credit and financial guarantees which would impact the Companys liquidity and capital resources to the extent customers accept and or use these
commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The notes to the Consolidated Financial Statements contain further discussion of the
nature, business purpose and elements of risk involved with these off-balance sheet arrangements. The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Companys financial
condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors.



Recent Accounting Pronouncements



Accounting pronouncements are established by various accountancy governing bodies to provide guidance in the principles and practices used for maintaining
accurate and consistent accounting records. The Company has established monitoring procedures for the review of new accounting pronouncements relating to the banking industry, in order to ensure that all transactions are in compliance with GAAP.
Recent accounting pronouncements considered to be applicable to the Company are included in Note 1 of the Consolidated Financial Statements within this report.



27



---

##### Table of Contents

Item 7. Consolidated Financial Statements.



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                          |  |     
|--------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                          |  | Page
|Report of Independent Registered Public Accounting Firm                                                   |  | 29  
|                                                                                                          | 
|Consolidated Balance Sheets as of December 31, 2004 and 2003                                              |  | 30  
|                                                                                                          | 
|Consolidated Statements of Income for the years ended December 31, 2004 and 2003                          |  | 31  
|                                                                                                          | 
|Consolidated Statements of Changes in Stockholders Equity for the years ended December 31, 2004 and 2003 |  | 32  
|                                                                                                          | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2004 and 2003                      |  | 33  
|                                                                                                          | 
|Notes to Consolidated Financial Statements                                                                |  | 34  



28



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##### Table of Contents

Report of Independent Registered Public Accounting Firm



To the Board of Directors

Pioneer Bankshares, Inc.

Stanley, Virginia



We have audited the consolidated balance sheets of
Pioneer Bankshares, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders equity and cash flows for each of the two years then ended. These financial statements are
the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Pioneer Bankshares, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the two years then ended, in
conformity with U.S. generally accepted accounting principles.



LOGO



Winchester, Virginia

February 3, 2005



29



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##### Table of Contents

PIONEER BANKSHARES, INC.



CONSOLIDATED BALANCE
SHEETS

DECEMBER 31, 2004 AND 2003

(In
Thousands, except share data)



|                                                                                                                     |  |      |         |      |   |        
|-------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                                                                                                     |  | 2004 |         | 2003
|ASSETS                                                                                                               |  |      |         |      |   |        
|                                                                                                                     |  |     
|Cash and due from banks                                                                                              |  | $    | 9,896   |      | $ | 7,579  
|Interest-bearing deposits in banks                                                                                   |  |      | 10,480  |      |   | 5,212  
|Federal funds sold                                                                                                   |  |      | 950     |      |   | 2,500  
|Securities available for sale, at fair value                                                                         |  |      | 12,331  |      |   | 18,348 
|Securities held to maturity (fair value was $16 and $33 in 2004 and 2003, respectively)                              |  |      | 16      |      |   | 31     
|Restricted securities                                                                                                |  |      | 1,181   |      |   | 557    
|Loans receivable, net of allowance for loan losses of $1,346 in 2004 and $1,433 in 2003                              |  |      | 92,283  |      |   | 80,781 
|Bank premises and equipment, net                                                                                     |  |      | 4,150   |      |   | 4,115  
|Accrued interest receivable                                                                                          |  |      | 491     |      |   | 497    
|Other assets                                                                                                         |  |      | 1,487   |      |   | 1,301  
|                                                                                                                     |  |      |         |      |   |        
|Total Assets                                                                                                         |  | $    | 133,265 |      | $ | 120,921
|                                                                                                                     |  |      |         |      |   |        
|LIABILITIES                                                                                                          |  |      |         |      |   |        
|                                                                                                                     |  |     
|Deposits                                                                                                             |  |      |         |      |   |        
|Noninterest bearing                                                                                                  |  | $    | 26,194  |      | $ | 21,181 
|Interest bearing                                                                                                     |  |      |         |      |   |        
|Demand                                                                                                               |  |      | 14,890  |      |   | 14,155 
|Savings                                                                                                              |  |      | 13,954  |      |   | 12,888 
|Time deposits over $100,000                                                                                          |  |      | 8,236   |      |   | 8,219  
|Other time deposits                                                                                                  |  |      | 37,523  |      |   | 43,148 
|                                                                                                                     |  |      |         |      |   |        
|Total Deposits                                                                                                       |  |      | 100,797 |      |   | 99,591 
|                                                                                                                     |  |     
|Accrued expenses and other liabilities                                                                               |  |      | 631     |      |   | 740    
|Long term debt                                                                                                       |  |      | 18,300  |      |   | 7,425  
|                                                                                                                     |  |      |         |      |   |        
|Total Liabilities                                                                                                    |  |      | 119,728 |      |   | 107,756
|                                                                                                                     |  |      |         |      |   |        
|STOCKHOLDERS EQUITY                                                                                                 |  |      |         |      |   |        
|                                                                                                                     |  |     
|Common stock; $.50 par value, authorized 5,000,000 shares; outstanding  1,034,045 in 2004; 1,073,650 shares in 2003 |  |      | 517     |      |   | 537    
|Retained earnings                                                                                                    |  |      | 12,918  |      |   | 12,464 
|Accumulated other comprehensive income, net                                                                          |  |      | 102     |      |   | 164    
|                                                                                                                     |  |      |         |      |   |        
|Total Stockholders Equity                                                                                           |  |      | 13,537  |      |   | 13,165 
|                                                                                                                     |  |      |         |      |   |        
|Total Liabilities and Stockholders Equity                                                                           |  | $    | 133,265 |      | $ | 120,921
|                                                                                                                     |  |      |         |      |   |        



See Notes to
Consolidated Financial Statements.



30



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##### Table of Contents

PIONEER BANKSHARES, INC.



CONSOLIDATED
STATEMENTS OF INCOME

YEARS ENDED DECEMBER 31, 2004 AND 2003

(In Thousands, except per share data)



|                                                    |  |      |       |      |   |      
|--------------------------------------------------- |  | ---- | ----- | ---- | - | -----
|                                                    |  | 2004 |       | 2003
|INTEREST AND DIVIDEND INCOME:                       |  |      |       |      |   |      
|Loans including fees                                |  | $    | 7,224 |      | $ | 7,523
|Interest on securities  taxable                    |  |      | 300   |      |   | 338  
|Interest on securities  nontaxable                 |  |      | 21    |      |   | 75   
|Deposits and federal funds sold                     |  |      | 194   |      |   | 166  
|Dividends                                           |  |      | 59    |      |   | 70   
|                                                    |  |      |       |      |   |      
|Total Interest and Dividend Income                  |  |      | 7,798 |      |   | 8,172
|                                                    |  |      |       |      |   |      
|INTEREST EXPENSE:                                   |  |      |       |      |   |      
|Deposits                                            |  |      | 1,335 |      |   | 1,745
|Long term debt                                      |  |      | 444   |      |   | 285  
|                                                    |  |      |       |      |   |      
|Total Interest Expense                              |  |      | 1,779 |      |   | 2,030
|                                                    |  |      |       |      |   |      
|NET INTEREST INCOME                                 |  |      | 6,019 |      |   | 6,142
|                                                    |  |     
|PROVISION FOR LOAN LOSSES                           |  |      | 72    |      |   | 948  
|                                                    |  |      |       |      |   |      
|NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |  |      | 5,947 |      |   | 5,194
|                                                    |  |      |       |      |   |      
|NONINTEREST INCOME:                                 |  |      |       |      |   |      
|Service charges on deposit accounts                 |  |      | 805   |      |   | 908  
|Commission income                                   |  |      | 10    |      |   | 49   
|Other income                                        |  |      | 68    |      |   | 225  
|Gain on security transactions                       |  |      | 305   |      |   | 292  
|                                                    |  |      |       |      |   |      
|Total Noninterest Income                            |  |      | 1,188 |      |   | 1,474
|                                                    |  |      |       |      |   |      
|NONINTEREST EXPENSES:                               |  |      |       |      |   |      
|Salaries and employee benefits                      |  |      | 2,203 |      |   | 2,128
|Occupancy expenses                                  |  |      | 295   |      |   | 265  
|Equipment expenses                                  |  |      | 785   |      |   | 750  
|Other expenses                                      |  |      | 1,498 |      |   | 1,578
|                                                    |  |      |       |      |   |      
|Total Noninterest Expenses                          |  |      | 4,781 |      |   | 4,721
|                                                    |  |      |       |      |   |      
|INCOME BEFORE INCOME TAXES                          |  |      | 2,354 |      |   | 1,947
|                                                    |  |     
|INCOME TAX EXPENSE                                  |  |      | 792   |      |   | 633  
|                                                    |  |      |       |      |   |      
|NET INCOME                                          |  | $    | 1,562 |      | $ | 1,314
|                                                    |  |      |       |      |   |      
|PER SHARE DATA                                      |  |      |       |      |   |      
|Net income, basic                                   |  | $    | 1.46  |      | $ | 1.20 
|                                                    |  |      |       |      |   |      
|Net income, diluted                                 |  | $    | 1.45  |      | $ | 1.20 
|                                                    |  |      |       |      |   |      
|Dividends                                           |  | $    | 0.48  |      | $ | 0.50 
|                                                    |  |      |       |      |   |      



See Notes to
Consolidated Financial Statements.



31



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##### Table of Contents

PIONEER BANKSHARES, INC.



CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

YEARS ENDED DECEMBER 31, 2004 AND 2003

(In Thousands, except share data)



|                                                                                         |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|---------------------------------------------------------------------------------------- |  | ----------- | --- | - | ---------------- | - | ------ | ----------------------------------- |  | - | ----- | - |  | - | ------ | -
|                                                                                         |  | CommonStock |     |   | RetainedEarnings |   |        | AccumulatedOtherComprehensiveIncome |  |   | Total |  
|BALANCE DECEMBER 31, 2002                                                                |  | $           | 546 |   |                  | $ | 11,913 |                                     |  | $ | 216   |   |  | $ | 12,675 |  
|                                                                                         |  |             |     |  
|Comprehensive Income                                                                     |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|Net Income                                                                               |  |             |     |   |                  |   | 1,314  |                                     |  |   |       |   |  |   | 1,314  |  
|Changes in unrealized gains on securities, net of taxes                                  |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|Unrealized holding gains arising during the period (net of tax effect of $84)            |  |             |     |   |                  |   |        |                                     |  |   | 136   |   |  |   |        |  
|Reclassification adjustment for gains included in net income (net of tax effect of $104) |  |             |     |   |                  |   |        |                                     |  |   | (188  | ) |  |   | (52    | )
|                                                                                         |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|Total Comprehensive Income                                                               |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   | 1,262  |  
|                                                                                         |  |             |     |  
|Cash Dividends                                                                           |  |             |     |   |                  |   | (546   | )                                   |  |   |       |   |  |   | (546   | )
|Retirement of common stock (18,699 shares)                                               |  |             | (9  | ) |                  |   | (217   | )                                   |  |   |       |   |  |   | (226   | )
|                                                                                         |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|BALANCE DECEMBER 31, 2003                                                                |  |             | 537 |   |                  |   | 12,464 |                                     |  |   | 164   |   |  |   | 13,165 |  
|                                                                                         |  |             |     |  
|Comprehensive Income                                                                     |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|Net Income                                                                               |  |             |     |   |                  |   | 1,562  |                                     |  |   |       |   |  |   | 1,562  |  
|Changes in unrealized gains on securities, net of taxes                                  |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|Unrealized holding gains arising during the period (net of tax effect of $77)            |  |             |     |   |                  |   |        |                                     |  |   | 139   |   |  |   |        |  
|Reclassification adjustment for gains included in net income (net of tax effect of $104) |  |             |     |   |                  |   |        |                                     |  |   | (201  | ) |  |   | (62    | )
|                                                                                         |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|Total Comprehensive Income                                                               |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   | 1,500  |  
|                                                                                         |  |             |     |  
|Cash Dividends                                                                           |  |             |     |   |                  |   | (515   | )                                   |  |   |       |   |  |   | (515   | )
|Retirement of common stock (39,605 shares)                                               |  |             | (20 | ) |                  |   | (593   | )                                   |  |   |       |   |  |   | (613   | )
|                                                                                         |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  
|BALANCE DECEMBER 31, 2004                                                                |  | $           | 517 |   |                  | $ | 12,918 |                                     |  | $ | 102   |   |  | $ | 13,537 |  
|                                                                                         |  |             |     |   |                  |   |        |                                     |  |   |       |   |  |   |        |  



See Notes to
Consolidated Financial Statements.



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PIONEER BANKSHARES, INC.



CONSOLIDATED
STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2004 AND 2003

(In Thousands)



|                                                                                         |  |      |         |   |      |   |         |  
|---------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                         |  | 2004 |         |   | 2003 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                    |  |      |         |   |      |   |         |  
|Net income                                                                               |  | $    | 1,562   |   |      | $ | 1,314   |  
|Adjustments to reconcile net income to net cash provided by operating activities:        |  |      |         |   |      |   |         |  
|Provision for loan losses                                                                |  |      | 72      |   |      |   | 948     |  
|(Gain) on security sales                                                                 |  |      | (305    | ) |      |   | (292    | )
|Net amortization on securities                                                           |  |      | 97      |   |      |   | 28      |  
|Deferred income tax expense (benefit)                                                    |  |      | 43      |   |      |   | (50     | )
|Depreciation                                                                             |  |      | 557     |   |      |   | 526     |  
|Net change in:                                                                           |  |      |         |   |      |   |         |  
|Accrued interest receivable                                                              |  |      | 6       |   |      |   | 47      |  
|Other assets                                                                             |  |      | (229    | ) |      |   | 118     |  
|Accrued expense and other liabilities                                                    |  |      | (82     | ) |      |   | (95     | )
|                                                                                         |  |      |         |   |      |   |         |  
|Net Cash Provided by Operating Activities                                                |  |      | 1,721   |   |      |   | 2,544   |  
|                                                                                         |  |      |         |   |      |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                    |  |      |         |   |      |   |         |  
|Net change in interest bearing deposits                                                  |  |      | (5,268  | ) |      |   | (401    | )
|Net change in federal funds sold                                                         |  |      | 1,550   |   |      |   | (2,000  | )
|Proceeds from maturities, sales, and principal payments of securities available for sale |  |      | 18,337  |   |      |   | 31,218  |  
|Proceeds from principal payments of securities held to maturity                          |  |      | 15      |   |      |   | 45      |  
|Purchase of securities available for sale                                                |  |      | (12,825 | ) |      |   | (29,845 | )
|Net (increase) decrease in loans                                                         |  |      | (11,574 | ) |      |   | 4,370   |  
|Purchase of bank premises and equipment                                                  |  |      | (592    | ) |      |   | (902    | )
|                                                                                         |  |      |         |   |      |   |         |  
|Net Cash Provided By (Used in) Investing Activities                                      |  |      | (10,357 | ) |      |   | 2,485   |  
|                                                                                         |  |      |         |   |      |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                    |  |      |         |   |      |   |         |  
|Net change in:                                                                           |  |      |         |   |      |   |         |  
|Demand and savings deposits                                                              |  |      | 6,814   |   |      |   | 2,389   |  
|Time deposits                                                                            |  |      | (5,608  | ) |      |   | (9,323  | )
|Proceeds from borrowings                                                                 |  |      | 23,000  |   |      |   | 3,000   |  
|Curtailments of borrowings                                                               |  |      | (12,125 | ) |      |   | (650    | )
|Purchase and subsequent retirement of common stock                                       |  |      | (613    | ) |      |   |        |  
|Dividends paid                                                                           |  |      | (515    | ) |      |   | (546    | )
|                                                                                         |  |      |         |   |      |   |         |  
|Net Cash Provided by (Used in) Financing Activities                                      |  |      | 10,953  |   |      |   | (5,130  | )
|                                                                                         |  |      |         |   |      |   |         |  
|CASH AND CASH EQUIVALENTS                                                                |  |      |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                     |  |      | 2,317   |   |      |   | (101    | )
|Cash and cash equivalents, beginning of year                                             |  |      | 7,579   |   |      |   | 7,680   |  
|                                                                                         |  |      |         |   |      |   |         |  
|Cash and Cash Equivalents, End of Year                                                   |  | $    | 9,896   |   |      | $ | 7,579   |  
|                                                                                         |  |      |         |   |      |   |         |  
|Supplemental Disclosure of Cash Paid During the Year for:                                |  |      |         |   |      |   |         |  
|Interest                                                                                 |  | $    | 1,843   |   |      |   | 2,202   |  
|Income taxes                                                                             |  |      | 656     |   |      |   | 558     |  
|                                                                                         |  |     
|Supplemental Disclosure of non-cash activity:                                            |  |      |         |   |      |   |         |  
|Unrealized (loss) on securities available for sale                                       |  |      | (89     | ) |      |   | (72     | )
|Receipt of common stock in exchange for donation of assets                               |  |      |        |   |      |   | (226    | )



See Notes to
Consolidated Financial Statements.



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##### Table of Contents

PIONEER BANKSHARES, INC.



NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1 SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES:



The accounting and reporting policies of Pioneer
Bankshares, Inc. (Company), and its subsidiary Pioneer Bank (Bank), conform to accounting principles generally accepted in the United States of America and to accepted practice within the banking industry. A summary of
significant accounting policies is as follows:



Consolidation
Policy - The consolidated financial statements of the Company include the Bank and Pioneer Financial Services, LLC., and Pioneer Special Assets, LLC., which are wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.



Use of Estimates  In
preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in
the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets.



Securities - Investment securities which the Company intends to hold until maturity or until called are classified as Held to Maturity. These investment
securities are carried at cost. Restricted securities include the Banks investments in Federal Reserve Bank stock and FHLB stock and are carried at cost.



Securities which the Company intends to hold for indefinite periods of time, including securities used as part of the Companys asset/liability management
strategy, are classified as available for sale. These securities are carried at fair value. Net unrealized gains and losses, net of deferred income taxes, are excluded from earnings and reported as a separate component of stockholders equity
until realized.



Purchase premiums and discounts are recognized in interest
income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized
losses. In estimating other-than temporary impairment losses, management considers 1) the length of time and the extent to which the fair value has been less than cost, 2) the financial condition and near term prospects of the issuer, and 3) the
intent and ability of the company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are
determined using the specific identification method.



Loans
Receivable - Loans receivable are intended to be held until maturity and are shown on the consolidated balance sheets net of unearned interest and the allowance for loan losses. Interest is computed by methods which generally result in level
rates of return on principal. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance.



The accrual of interest on loans is discontinued at the time the loan is 90
days delinquent unless the credit is well-secured and in process of collection. Personal loans are typically charged off no later than 120 days past due unless the loan is well secured and in the process of collection. However, loans 120 days or
more past due, with at least a 60-day recovery in payments are not charge offs. In most cases, loans are placed on non-accrual or charged off at an earlier date if collection of principal or interest is considered doubtful.



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##### Table of Contents

PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):



Loans Receivable (continued) - All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest
income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought
current and future payments are reasonably assured.



Allowance for Loan
Losses  The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance that management considers adequate to absorb potential losses in the portfolio. Loans
are charged against the allowance when management believes the collectibility of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Managements determination of the adequacy of the allowance
is based on the evaluation of the composition of the loan portfolio, the value and adequacy of collateral, current economic conditions, historical loan loss experience, and other risk factors. Management believes that the allowance for loan losses
is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values. In addition,
regulatory agencies, as an integral part of their examination process, periodically review the Companys allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about
information available to them at the time of their examination.



The allowance
consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss
experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect managements estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision
inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.



A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest
payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking
into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrowers prior payment record, and the amount of the shortfall in relation to the principal and
interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loans obtainable market
price, or the fair value of the collateral if the loan is collateral dependent.



Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not generally separately identify individual consumer loans for impairment disclosures.



35



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):



Bank Premises and Equipment  Land values are carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation.
Depreciation is charged to income over the estimated useful lives ranging from 3 to 40 years of the assets on a combination of straight-line and accelerated methods.



Income Taxes  Amounts provided for income tax expense are based on income reported for financial statement purposes
rather than amounts currently payable under income tax laws. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized
or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.



Financial Instruments - In the ordinary course of business, the Bank has entered into off-balance-sheet financial instruments consisting of commitments to
extend credit, commitments under credit-card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded.



The Banks exposure to credit loss is represented by the contractual amount of these
commitments. The Bank uses the same credit policies in making commitments as it does for other loans. Commitments to extend credit are generally made for a period of one year or less and interest rates are determined when funds are disbursed.
Collateral and other security for the loans are determined on a case-by-case basis. Since some of the commitments are expected to expire without being drawn upon, the contract or notional amounts do not necessarily represent future cash
requirements.



Cash and Cash Equivalents  For purposes of
reporting cash flows, cash and cash equivalents include cash on hand.



Advertising Costs - The Company follows the policy of charging the production costs of advertising to expense as incurred. Advertising expense amounted to $62,401 and $62,214 for the years ended December 31, 2004 and 2003,
respectively.



Earnings Per Share Basic earnings per share
represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive
potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using
the treasury stock method.



Stock Compensation PlansThe Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all
options granted under the plan have an exercise price equal to the market value of the underlying common stock on the date of the grant.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):



Stock Compensation Plans (continued) - The following table illustrates the effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation (dollars in thousands except per share amounts):



|                                                                                                 |  |      |       |   |      |   |       |  
|------------------------------------------------------------------------------------------------ |  | ---- | ----- | - | ---- | - | ----- | -
|                                                                                                 |  | 2004 |       |   | 2003 |  
|Net Income, as reported                                                                          |  | $    | 1,562 |   |      | $ | 1,314 |  
|Total stock-based compensation expenses determined under fair value based method for all rewards |  |      | (2    | ) |      |   | (4    | )
|                                                                                                 |  |      |       |   |      |   |       |  
|Pro forma net income                                                                             |  | $    | 1,560 |   |      | $ | 1,310 |  
|                                                                                                 |  |      |       |   |      |   |       |  
|Basic earnings per share                                                                         |  |      |       |   |      |   |       |  
|As reported                                                                                      |  | $    | 1.46  |   |      | $ | 1.20  |  
|                                                                                                 |  |      |       |   |      |   |       |  
|Pro forma                                                                                        |  | $    | 1.45  |   |      | $ | 1.20  |  
|                                                                                                 |  |      |       |   |      |   |       |  
|Diluted earnings per share                                                                       |  |      |       |   |      |   |       |  
|As reported                                                                                      |  | $    | 1.45  |   |      | $ | 1.20  |  
|                                                                                                 |  |      |       |   |      |   |       |  
|Pro forma                                                                                        |  | $    | 1.45  |   |      | $ | 1.20  |  
|                                                                                                 |  |      |       |   |      |   |       |  



The fair value of each grant is
estimated at the grant date using the Black-Scholes option-pricing model. The estimates were calculated using the following weighted-average assumptions for grants in 2004 and 2003: Dividend rate of 3.43% and 3.75%, price volatility of 19.94% and
17.58%, risk-free interest rate of 4.81% and 3.34%, and expected lives of 10 years.



Reclassifications - Certain reclassifications have been made to prior period balances to conform to the current year presentation.



Recent Accounting Pronouncements - On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No. 105, Application of Accounting Principles to
Loan Commitments (SAB 105). SAB 105 clarifies existing accounting practices relating to the valuation of issued loan commitments, including interest rate lock commitments (IRLC), subject to SFAS No. 149 and Derivative
Implementation Group Issue C13, Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133. Furthermore, SAB 105 disallows the inclusion of the values of a servicing component and other internally developed
intangible assets in the initial and subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The Company has adopted the provisions of SAB 105. Since the provisions of SAB 105
affect only the timing of the recognition of mortgage banking income, management does not anticipate that this guidance will have a material adverse effect on either the Companys consolidated financial position or consolidated results of
operations.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):



Recent Accounting Pronouncements (continued) -Emerging Issues Task Force Issue No. (EITF) 03-1 The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments was issued and is effective March 31, 2004. The EITF 03-1 provides guidance for determining the meaning of other than-temporarily impaired and its application to certain debt and equity
securities within the scope of Statement of Financial Accounting Standards No. 115 Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115) and investments accounted for under the cost method. The
guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold
the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. This issue also requires disclosures assessing the ability and intent to hold investments in
instances in which an investor determines that an investment with a fair value less than cost is not other-than-temporarily impaired. On September 30, 2004, the Financial Accounting Standards Board decided to delay the effective date for the
measurement and recognition guidance contained in Issue 03-1. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure guidance in Issue 03-1 was not
delayed.



EITF No. 03-16, Accounting for Investments in Limited Liability
Companies was ratified by the Board and is effective for reporting periods beginning after June 15, 2004. APB Opinion No. 18, The Equity Method of Accounting Investments in Common Stock, prescribes the accounting for investments in
common stock of corporations that are not consolidated. AICPA Accounting Interpretation 2, Investments in Partnerships Ventures, of Opinion 18, indicates that many of the provisions of the Opinion would be appropriate in
accounting for partnerships. In EITF Abstracts, Topic No. D-46, Accounting for Limited Partnership Investments, the SEC staff clarified its view that investments of more than 3 to 5 percent are considered to be more than minor and,
therefore, should be accounted for using the equity method. Limited liability companies (LLCs) have characteristics of both corporations and partnerships, but are dissimilar from both in certain respects. Due to those similarities and differences,
diversity in practice exists with respect to accounting for non-controlling investments in LLCs. The consensus reached was that an LLC should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a
non-controlling investment should be accounted for using the cost method or the equity method of accounting.



In December 2003, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-3, Accounting for
Certain Loans or Debt Securities Acquired in a Transfer. The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The scope of the SOP applies to unhealthy problem loans that have been acquired,
either individually in a portfolio, or in a business acquisition. The SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investors initial investment in loans or debt
securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. The SOP does not apply to loans originated by the Company. The Company intends to adopt the provisions of SOP 03-3 effective
January 1, 2005, and does not expect the initial implementation to have a significant effect on the Companys consolidated financial position or consolidated results of operations.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):



Recent Accounting Pronouncements (continued)- In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities
in exchange for goods or services that are based on the fair value of the entitys equity instruments or that may be settled by the issuance of those equity instruments. The Statement focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions. The Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award  the requisite service period (usually the vesting period). The entity will
initially measure the cost of employee services received in exchange for an award of liability instruments based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement
date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period.



The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those
instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value
of the modified award over the fair value of the original award immediately before the modification. This Statement is effective for public entities that do not file as small business issuersas of the beginning of the first interim or annual
reporting period that begins after June 15, 2005. For public companies that file as small business issuers  as of the beginning of the first interim or annual reporting period that begins after December 15, 2005. Under the transition method,
compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under Statement
123 for either recognition or pro forma disclosures. For periods before the required effective date, entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a
basis consistent with the pro forma disclosures required for those periods by Statement 123.



The Company does not believe that any newly issued but as yet unapplied accounting standards will have a material impact on the Companys financial position or operations.



NOTE 2 NATURE OF OPERATIONS:



The Company operates under a charter issued by the Commonwealth of Virginia and provides
commercial banking services. As a state chartered bank, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank. The Bank provides services at six separate locations to customers in the City of
Harrisonburg and Page and Green Counties of Virginia. The Bank also operates a separate financial subsidiary known as Pioneer Financial Services, LLC, which offers a variety of consumer investment and insurance services.



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##### Table of Contents

PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 3 CASH AND DUE FROM BANKS:



The Bank is required to maintain average reserve balances based on a percentage of deposits. The average balance of cash, which the Federal Reserve Bank requires to be on
reserve, was $1.0 million and $1.1 million at December 31, 2004 and 2003, respectively.



NOTE 4 DEPOSITS IN AND FEDERAL FUNDS SOLD TO BANKS:



The Bank has cash deposited in and federal funds sold to other banks, most of which exceed federally insured limits, totaling $9.9 million and $10.9 million at December 31, 2004 and 2003, respectively.



NOTE 5 INVESTMENT SECURITIES:



The amortized cost and fair value of investment securities are as follows:



|                                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|------------------------------------- |  | -------------- | ------ | --------------------- | - | --------------------- |  | - | --------- | - |  | - | ------
|                                      |  | AmortizedCost  |        | Gross UnrealizedGains |   | GrossUnrealizedLosses |  |   | FairValue
|                                      |  | (In Thousands)
|December 31, 2004                     |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|                                      |  |                |        |                      
|Available for Sale                    |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|U.S. government and agency securities |  | $              | 10,154 |                       | $ | 3                     |  | $ | (79       | ) |  | $ | 10,078
|State and municipals                  |  |                | 214    |                       |   | 15                    |  |   |          |   |  |   | 229   
|Equity securities                     |  |                | 1,794  |                       |   | 230                   |  |   |          |   |  |   | 2,024 
|                                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|                                      |  | $              | 12,162 |                       | $ | 248                   |  | $ | (79       | ) |  | $ | 12,331
|                                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|Held to Maturity                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|Mortgage-backed                       |  | $              | 16     |                       | $ |                      |  | $ |          |   |  | $ | 16    
|                                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|                                      |  |                |        |                      
|December 31, 2003                     |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|                                      |  |                |        |                      
|Available for Sale                    |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|U.S. government and agency securities |  | $              | 14,836 |                       | $ | 18                    |  | $ | (22       | ) |  | $ | 14,832
|State and municipals                  |  |                | 1,710  |                       |   | 117                   |  |   |          |   |  |   | 1,827 
|Equity securities                     |  |                | 1,546  |                       |   | 143                   |  |   |          |   |  |   | 1,689 
|                                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|                                      |  | $              | 18,092 |                       | $ | 278                   |  | $ | (22       | ) |  | $ | 18,348
|                                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|Held to Maturity                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       
|Mortgage-backed                       |  | $              | 31     |                       | $ | 2                     |  | $ |          |   |  | $ | 33    
|                                      |  |                |        |                       |   |                       |  |   |           |   |  |   |       



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 5 INVESTMENT SECURITIES (Continued):



The amortized cost and fair value of investment securities at December 31, 2004, by contractual maturity, are shown in the following schedule. Expected maturities will
differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



|                                      |  |                               |        |                             |   |               |  |           |    |  |   |   
|------------------------------------- |  | ----------------------------- | ------ | --------------------------- | - | ------------- |  | --------- | -- |  | - | --
|                                      |  | Securities Available for Sale |        | Securities Held to Maturity
|(In Thousands)                        |  | AmortizedCost                 |        | FairValue                   |   | AmortizedCost |  | FairValue
|Due within one year                   |  | $                             | 1,278  |                             | $ | 1,270         |  | $         |   |  | $ |  
|Due after one year through five years |  |                               | 8,080  |                             |   | 8,013         |  |           |   |  |   |  
|Due five years through ten years      |  |                               | 214    |                             |   | 229           |  |           |   |  |   |  
|Due after ten years                   |  |                               |       |                             |   |              |  |           |   |  |   |  
|                                      |  |                               |        |                             |   |               |  |           |    |  |   |   
|                                      |  |                               | 9,572  |                             |   | 9,512         |  |           |   |  |   |  
|                                      |  |                               |        |                            
|Mortgage-backed                       |  |                               | 796    |                             |   | 795           |  |           | 16 |  |   | 16
|Equity securities                     |  |                               | 1,794  |                             |   | 2,024         |  |           |   |  |   |  
|                                      |  |                               |        |                             |   |               |  |           |    |  |   |   
|                                      |  | $                             | 12,162 |                             | $ | 12,331        |  | $         | 16 |  | $ | 16
|                                      |  |                               |        |                             |   |               |  |           |    |  |   |   



Realized gains and losses on available
for sale securities are summarized below:



|          |  |                |     |   |      |   |     |  
|--------- |  | -------------- | --- | - | ---- | - | --- | -
|          |  | 2004           |     |   | 2003 |  
|          |  | (In Thousands) |    
|Gains     |  | $              | 352 |   |      | $ | 362 |  
|Losses    |  |                | (47 | ) |      |   | (70 | )
|          |  |                |     |   |      |   |     |  
|Net Gains |  | $              | 305 |   |      | $ | 292 |  
|          |  |                |     |   |      |   |     |  



Investment securities with a book
value of $1,210,000 and $1,232,000 at December 31, 2004 and 2003, respectively, were pledged to secure public deposits and for other purposes required by law.



Securities in an unrealized loss position at December 31, 2004 and 2003, by duration of the unrealized loss are shown below. In analyzing an issuers financial
condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts reports. No impairment has been recognized on any of
the securities in a loss position because of managements intent and demonstrated ability to hold securities to scheduled maturity or call dates.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 5 INVESTMENT SECURITIES (Continued):



As of December 31, 2004, there are approximately 10 securities in the portfolio that have losses, which are considered to be temporary. The schedule of losses on these
securities is as follows:



|                      |  |                   |  |                                |   |  |                           |   |  |       |  
|--------------------- |  | ----------------- |  | ------------------------------ | - |  | ------------------------- | - |  | ----- | -
|LOSSES (In Thousands) |  |                   |  | US GovernmentAgency Securities |   |  | Mortgage-BackedSecurities |   |  | Total |  
|Less than 12 Mths     |  | Fair Value        |  | 7,778                          |   |  |                          |   |  | 7,778 |  
|                      |  | Unrealized Losses |  | (76                            | ) |  |                          |   |  | (76   | )
|                      |  |                   |  |                               
|More than 12 Mths     |  | Fair Value        |  |                               |   |  | 254                       |   |  | 254   |  
|                      |  | Unrealized Losses |  |                               |   |  | (3                        | ) |  | (3    | )
|                      |  |                   |  |                                |   |  |                           |   |  |       |  
|Total                 |  | Fair Value        |  | 7,778                          |   |  | 254                       |   |  | 8,032 |  
|                      |  |                   |  |                                |   |  |                           |   |  |       |  
|                      |  | Unrealized Losses |  | (76                            | ) |  | (3                        | ) |  | (79   | )
|                      |  |                   |  |                                |   |  |                           |   |  |       |  



As of December 31, 2003, there were
approximately 8 securities in the portfolio that had losses, which were considered to be temporary. The schedule of losses on these securities is as follows:



|                      |  |                   |  |                                |   |  |                           |   |  |       |  
|--------------------- |  | ----------------- |  | ------------------------------ | - |  | ------------------------- | - |  | ----- | -
|LOSSES (In Thousands) |  |                   |  | US GovernmentAgency Securities |   |  | Mortgage-BackedSecurities |   |  | Total |  
|Less than 12 Mths     |  | Fair Value        |  | 7,096                          |   |  | 450                       |   |  | 7,546 |  
|                      |  | Unrealized Losses |  | (20                            | ) |  | (2                        | ) |  | (22   | )
|                      |  |                   |  |                               
|More than 12 Mths     |  | Fair Value        |  |                               |   |  |                          |   |  |      |  
|                      |  | Unrealized Losses |  |                               |   |  |                          |   |  |      |  
|                      |  |                   |  |                                |   |  |                           |   |  |       |  
|Total                 |  | Fair Value        |  | 7,096                          |   |  | 450                       |   |  | 7,546 |  
|                      |  |                   |  |                                |   |  |                           |   |  |       |  
|                      |  | Unrealized Losses |  | (20                            | ) |  | (2                        | ) |  | (22   | )
|                      |  |                   |  |                                |   |  |                           |   |  |       |  



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 6 LOANS:



Loans are stated at their face amount, net of unearned discount, and are classified as follows at December 31:



|                                  |  |                  |        |   |                  |   |        |  
|--------------------------------- |  | ---------------- | ------ | - | ---------------- | - | ------ | -
|                                  |  | (In Thousands)   |       
|                                  |  | December 31,2004 |        |   | December 31,2003 |  
|Mortgage loans on real estate     |  |                  |        |   |                  |   |        |  
|Construction loans                |  | $                | 7,193  |   |                  | $ | 5,929  |  
|Agricultural                      |  |                  | 4,607  |   |                  |   | 4,809  |  
|Equity lines of credit            |  |                  | 1,738  |   |                  |   | 1,853  |  
|Residential 1-4 family            |  |                  | 41,125 |   |                  |   | 37,930 |  
|Second Mortgages                  |  |                  | 3,305  |   |                  |   | 2,726  |  
|Multifamily                       |  |                  | 1,853  |   |                  |   | 517    |  
|Commercial                        |  |                  | 17,046 |   |                  |   | 10,712 |  
|                                  |  |                  |        |   |                  |   |        |  
|Total real estate loans           |  |                  | 76,867 |   |                  |   | 64,476 |  
|                                  |  |                 
|Commercial and agricultural loans |  |                  | 3,548  |   |                  |   | 3,794  |  
|Consumer installment loans        |  |                  |        |   |                  |   |        |  
|Personal                          |  |                  | 13,641 |   |                  |   | 14,416 |  
|Credit cards                      |  |                  | 729    |   |                  |   | 803    |  
|                                  |  |                  |        |   |                  |   |        |  
|Total consumer installment loans  |  |                  | 14,370 |   |                  |   | 15,219 |  
|All other loans                   |  |                  | 166    |   |                  |   | 260    |  
|                                  |  |                  |        |   |                  |   |        |  
|Gross Loans                       |  |                  | 94,951 |   |                  |   | 83,749 |  
|                                  |  |                 
|Less unearned income on loans     |  |                  | (1,322 | ) |                  |   | (1,535 | )
|                                  |  |                  |        |   |                  |   |        |  
|Loans, less unearned discount     |  |                  | 93,629 |   |                  |   | 82,214 |  
|                                  |  |                 
|Less allowance for loan losses    |  |                  | (1,346 | ) |                  |   | (1,433 | )
|                                  |  |                  |        |   |                  |   |        |  
|Net Loans Receivable              |  | $                | 92,283 |   |                  | $ | 80,781 |  
|                                  |  |                  |        |   |                  |   |        |  



The Bank grants commercial, real
estate and consumer installment loans to its customers. Collateral requirements for loans are determined on a case by case basis depending upon the purpose of the loan and the financial condition of the borrower.



Deposit accounts reclassified as loans totaled $41,000 and $142,000 as of December 31, 2004
and 2003, respectively.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 6 LOANS (Continued):



The following is a summary of information pertaining to impaired loans for the years ended December 31, 2004 and 2003:



|                                                             |  |                |     |      |   |    
|------------------------------------------------------------ |  | -------------- | --- | ---- | - | ---
|                                                             |  | 2004           |     | 2003
|                                                             |  | (In Thousands)
|Impaired loans with a valuation allowance                    |  | $              | 620 |      | $ | 461
|Impaired loans without a valuation allowance                 |  |                |    |      |   |   
|                                                             |  |                |     |      |   |    
|Total Impaired loans                                         |  | $              | 620 |      | $ | 461
|                                                             |  |                |     |      |   |    
|Valuation allowance related to impaired loans                |  | $              | 175 |      | $ | 145
|                                                             |  |                |     |      |   |    
|Average investment in impaired loans                         |  | $              | 511 |      | $ | 259
|                                                             |  |                |     |      |   |    
|Interest income recognized on impaired loans                 |  | $              | 51  |      | $ | 23 
|                                                             |  |                |     |      |   |    
|Interest income recognized on a cash basis on impaired loans |  | $              |    |      | $ |   
|                                                             |  |                |     |      |   |    



No additional funds are committed to
be advanced in connection with impaired loans.



Nonaccrual loans excluded from
impaired loan disclosure under FASB Statement No. 114 amounted to $271,000 and $212,000 at December 31, 2004 and 2003, respectively. If interest on these loans had been accrued, such income would have approximated $1,000 and $11,000 for 2004 and
2003, respectively.



Loans past due greater than 90 days and still accruing
interest at December 31, 2004 and 2003 totaled $428,000 and $321,000, respectively.



NOTE 7 ALLOWANCE FOR LOAN LOSSES:



A summary of
transactions in the allowance for loan losses is as follows:



|                                        |  |                |       |   |      |   |        |  
|--------------------------------------- |  | -------------- | ----- | - | ---- | - | ------ | -
|                                        |  | 2004           |       |   | 2003 |  
|                                        |  | (In Thousands) |      
|Balance, beginning of year              |  | $              | 1,433 |   |      | $ | 1,448  |  
|Provision charged to operating expenses |  |                | 72    |   |      |   | 948    |  
|Recoveries of loans charged off         |  |                | 459   |   |      |   | 620    |  
|Loans charged off                       |  |                | (618  | ) |      |   | (1,583 | )
|                                        |  |                |       |   |      |   |        |  
|Balance, End of Year                    |  | $              | 1,346 |   |      | $ | 1,433  |  
|                                        |  |                |       |   |      |   |        |  



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 8 BANK PREMISES, EQUIPMENT and SOFTWARE:



Bank premises, equipment and computer software included in the financial statements at December 31, 2004 and 2003 are as follows:



|                                |  |                |       |      |   |      
|------------------------------- |  | -------------- | ----- | ---- | - | -----
|                                |  | 2004           |       | 2003
|                                |  | (In Thousands)
|Land                            |  | $              | 691   |      | $ | 691  
|Land improvements and buildings |  |                | 3,374 |      |   | 3,337
|Furniture and equipment         |  |                | 3,826 |      |   | 3,675
|Construction in process         |  |                | 365   |      |   | 7    
|Computer software               |  |                | 1,021 |      |   | 975  
|                                |  |                |       |      |   |      
|                                |  |                | 9,277 |      |   | 8,685
|Less accumulated depreciation   |  |                | 5,127 |      |   | 4,570
|                                |  |                |       |      |   |      
|Net                             |  | $              | 4,150 |      | $ | 4,115
|                                |  |                |       |      |   |      



Depreciation and amortization related
to bank premises, equipment and software included in operating expense for 2004 and 2003 was $557,000 and $526,000, respectively.



NOTE 9 TIME DEPOSITS:



At December 31, 2004, the scheduled maturities of time deposits (in thousands) are as follows:



|      |  |   |       
|----- |  | - | ------
|2005  |  | $ | 24,508
|2006  |  |   | 6,792 
|2007  |  |   | 9,431 
|2008  |  |   | 2,680 
|2009  |  |   | 2,348 
|      |  |   |       
|Total |  | $ | 45,759
|      |  |   |       



NOTE 10 LONG-TERM DEBT:



The Bank has a line of credit with the Federal Home
Loan Bank of Atlanta upon which credit advances can be made up to 40% of total assets, subject to certain eligibility requirements. This represents a total credit line of approximately $53.3 million and $48.4 million as of December 31, 2004 and
2003, respectively. FHLB advances bear interest at a fixed or floating rate depending on the terms and maturity of each advance and numerous renewal options are available. These advances are secured by 1-4 family residential mortgages. On some fixed
rate advances, the FHLB may convert the advance to an indexed floating rate at some set point in time for the remainder of the term. If the advance converts to a floating rate, the Bank may pay back all or part of the advance without a prepayment
penalty. Floating rate advances may be paid back at any time without penalty.



In December 2004, the Bank refinanced a portion of its outstanding debt and obtained additional borrowings in preparation for anticipated loan growth and funding needs during 2005. The refinance portion of this debt
was approximately $4 million, with new borrowings of $8 million, for a total new loan amount of $12 million. A prepayment penalty of $189,000 was paid on the refinanced debt and is reflected in noninterest expense. Managements decision to
utilize FHLB borrowings as a primary source of funds is based on the current low interest rate market and the potential for an increased interest margin going forward.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 10 LONG TERM DEBT (Continued):



At December 31, 2004, the total fixed-rate long-term debt with FHLB totaled $18.3 million and matures through December 30, 2009. The interest rates on the
fixed-rate notes payable ranges from 2.92% to 3.92%. At December 31, 2003, the total fixed-rate long-term debt with FHLB was $4.4 million. At December 31, 2003, the Company had outstanding floating rate debt of $3 million. The floating debt was
converted to a fixed rate debt during 2004. Therefore; there were no floating-rate long-term debts outstanding for the Company as of December 31, 2004



The contractual maturities of FHLB advances as of December 31, 2004 are as follows:



|            |  |                           |       
|----------- |  | ------------------------- | ------
|            |  | (In Thousands) Fixed Rate
|Due in 2005 |  | $                         | 3,800 
|Due in 2006 |  |                           | 3,800 
|Due in 2007 |  |                           | 3,800 
|Due in 2008 |  |                           | 3,800 
|Due in 2009 |  |                           | 3,100 
|            |  |                           |       
|            |  | $                         | 18,300
|            |  |                           |       



NOTE 11 OTHER EXPENSES:



Other expenses in the consolidated statements of income include the
following components:



|                      |  |                |       |      |   |      
|--------------------- |  | -------------- | ----- | ---- | - | -----
|                      |  | 2004           |       | 2003
|                      |  | (In Thousands)
|Supplies and printing |  | $              | 142   |      | $ | 153  
|Directors fees        |  |                | 162   |      |   | 146  
|Professional fees     |  |                | 182   |      |   | 213  
|Telephone             |  |                | 117   |      |   | 126  
|Prepayment penalties  |  |                | 189   |      |   |     
|Other                 |  |                | 706   |      |   | 940  
|                      |  |                |       |      |   |      
|Total                 |  | $              | 1,498 |      | $ | 1,578
|                      |  |                |       |      |   |      



NOTE 12 DIVIDEND LIMITATION ON
SUBSIDIARY BANK:



The principal source of funds of the Company is
dividends paid by the Bank. The amount of dividends the Bank may pay is regulated by the Federal Reserve. As of January 1, 2005, the maximum amount of dividends the Bank can pay to the Company is $1,465,000 or 10.8% of the consolidated net assets,
without requesting permission from the Federal Reserve Bank.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 13 INCOME TAXES:



The components of income tax expense are as follows:



|                                      |  |                |     |      |   |     |  
|------------------------------------- |  | -------------- | --- | ---- | - | --- | -
|                                      |  | 2004           |     | 2003 |  
|                                      |  | (In Thousands) |    
|Current income tax expense            |  | $              | 749 |      | $ | 683 |  
|Deferred income tax expense (benefit) |  |                | 43  |      |   | (50 | )
|                                      |  |                |     |      |   |     |  
|Income Tax Expense                    |  | $              | 792 |      | $ | 633 |  
|                                      |  |                |     |      |   |     |  



The reasons for the differences
between income tax expense and the amount computed by applying the statutory federal income tax rate are as follows:



|                                                                |  |                |     |   |      |   |     |  
|--------------------------------------------------------------- |  | -------------- | --- | - | ---- | - | --- | -
|                                                                |  | 2004           |     |   | 2003 |  
|                                                                |  | (In Thousands) |    
|Income taxes computed at the applicable federal income tax rate |  | $              | 800 |   |      | $ | 662 |  
|(Decrease) resulting from:                                      |  |                |     |   |      |   |     |  
|Tax-exempt municipal income                                     |  |                | (8  | ) |      |   | (24 | )
|State income taxes                                              |  |                |    |   |      |   | (1  | )
|Other                                                           |  |                |    |   |      |   | (4  | )
|                                                                |  |                |     |   |      |   |     |  
|Income Tax Expense                                              |  | $              | 792 |   |      | $ | 633 |  
|                                                                |  |                |     |   |      |   |     |  



At December 31, the net deferred tax
asset was made up of the following:



|                                       |  |                |     |      |   |    
|-------------------------------------- |  | -------------- | --- | ---- | - | ---
|                                       |  | 2004           |     | 2003
|                                       |  | (In Thousands)
|Deferred Tax Assets:                   |  |                |     |      |   |    
|Provision for loan losses              |  | $              | 246 |      | $ | 320
|Deferred compensation                  |  |                | 60  |      |   | 55 
|Prepayment Penalties (FHLB)            |  |                | 64  |      |   |   
|Capital loss carryover                 |  |                |    |      |   | 61 
|Other                                  |  |                | 6   |      |   |   
|                                       |  |                |     |      |   |    
|Total                                  |  | $              | 376 |      |   | 436
|                                       |  |                |     |      |   |    
|Deferred Tax Liabilities               |  |                |     |      |   |    
|Depreciation                           |  |                | 144 |      |   | 171
|Cash surrender value of life insurance |  |                | 19  |      |   | 16 
|Securities available for sale          |  |                | 67  |      |   | 93 
|Other                                  |  |                | 26  |      |   | 19 
|                                       |  |                |     |      |   |    
|Total                                  |  |                | 256 |      |   | 299
|                                       |  |                |     |      |   |    
|Net Deferred Tax Asset                 |  | $              | 120 |      | $ | 137
|                                       |  |                |     |      |   |    



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 14 REGULATORY MATTERS:



The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Companys financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Companys capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not
applicable to the bank holding company.



Quantitative measures established by
regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of
Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2004 and 2003, that the Company and the Bank met all capital adequacy requirements to which they were subject.



As of December 31, 2004, the most recent notification from the institutions primary
federal regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios
as set forth in the table. There are no conditions or events since that notification that management believes have changed the institutions category.



The Companys and the Banks actual capital amounts and ratios are also presented below: (in thousands)



|                                        |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|--------------------------------------- |  | ------ | ------ | ----- | ---------------------------- | - | ------ | ----------------------------- | ----- |  | - | ------ | - | ----- | - | ----- |  | - | ---- | -
|                                        |  | Actual |        |       | For CapitalAdequacy Purposes |   |        | Minimum To Be WellCapitalized |      
|                                        |  | Amount |        | Ratio |                              |   | Amount |                               | Ratio |  |   | Amount |   | Ratio |  
|As of December 31, 2004:                |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Total Capital to Risk Weighted Assets:  |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Consolidated                            |  | $      | 14,139 |       | 16.6                         | % |        | $                             | 6,807 |  | 3 | 8.0    | % |       |   | N/A   |  |   | N/A  |  
|Pioneer Bank                            |  | $      | 11,099 |       | 13.5                         | % |        | $                             | 6,599 |  | 3 | 8.0    | % |       | $ | 8,249 |  | 3 | 10.0 | %
|Tier I Capital to Risk Weighted Assets: |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Consolidated                            |  | $      | 13,075 |       | 15.4                         | % |        | $                             | 3,403 |  | 3 | 4.0    | % |       |   | N/A   |  |   | N/A  |  
|Pioneer Bank                            |  | $      | 10,064 |       | 12.2                         | % |        | $                             | 3,300 |  | 3 | 4.0    | % |       | $ | 4,949 |  | 3 | 6.0  | %
|Tier I Capital to Average Assets:       |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Consolidated                            |  | $      | 13,075 |       | 10.5                         | % |        | $                             | 4,961 |  | 3 | 4.0    | % |       |   | N/A   |  |   | N/A  |  
|Pioneer Bank                            |  | $      | 10,064 |       | 8.3                          | % |        | $                             | 4,847 |  | 3 | 4.0    | % |       | $ | 6,059 |  | 3 | 5.0  | %
|                                        |  |        |        |       |                              |  
|As of December 31, 2003:                |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Total Capital to Risk Weighted Assets:  |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Consolidated                            |  | $      | 13,561 |       | 18.0                         | % |        | $                             | 6,031 |  | 3 | 8.0    | % |       |   | N/A   |  |   | N/A  |  
|Pioneer Bank                            |  | $      | 11,103 |       | 15.2                         | % |        | $                             | 5,846 |  | 3 | 8.0    | % |       | $ | 7,308 |  | 3 | 10.0 | %
|Tier I Capital to Risk Weighted Assets: |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Consolidated                            |  | $      | 12,641 |       | 16.8                         | % |        | $                             | 3,015 |  | 3 | 4.0    | % |       |   | N/A   |  |   | N/A  |  
|Pioneer Bank                            |  | $      | 10,183 |       | 13.9                         | % |        | $                             | 2,923 |  | 3 | 4.0    | % |       | $ | 4,385 |  | 3 | 6.0  | %
|Tier I Capital to Average Assets:       |  |        |        |       |                              |   |        |                               |       |  |   |        |   |       |   |       |  |   |      |  
|Consolidated                            |  | $      | 12,641 |       | 10.6                         | % |        | $                             | 4,770 |  | 3 | 4.0    | % |       |   | N/A   |  |   | N/A  |  
|Pioneer Bank                            |  | $      | 10,183 |       | 8.7                          | % |        | $                             | 4,680 |  | 3 | 4.0    | % |       | $ | 5,848 |  | 3 | 5.0  | %



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 15 STOCK OPTION PLAN:



The Companys 1998 Stock Incentive Plan (the Plan) was adopted by the Board of Directors on June 11, 1998 and approved by the shareholders on June 11,
1999. The Plan makes available up to 14,000 shares of common stock for awards to employees and to non-employee directors of the Company and its subsidiaries in the form of stock options (Options).



Generally, the Plan provides for the grants of incentive stock options and non-qualified
stock options. The exercise price of an Option cannot be less than 100% of the fair market value of the common stock (or if greater, the book value) on the date of the grant. The option terms applicable to each grant are determined at the grant
date, but no Option can be exercisable in any event, after ten years from its grant date. On May 14, 2004, the Board of Directors granted Options to current non-employee directors for 2004. The effective date of the grant is May 14, 2004 and the
Options may be exercised on or after May 14, 2005.



A summary of the activity
in the Companys stock option plan is as follows:



|                                                               |  |                |  |                              |       |                |       |                              |   |      
|-------------------------------------------------------------- |  | -------------- |  | ---------------------------- | ----- | -------------- | ----- | ---------------------------- | - | -----
|                                                               |  | 2004           |  | 2003                        
|                                                               |  | NumberofShares |  | WeightedAverageExercisePrice |       | NumberofShares |       | WeightedAverageExercisePrice
|Outstanding at beginning of year                               |  | 4,700          |  | $                            | 13.49 |                | 3,900 |                              | $ | 13.69
|Granted                                                        |  | 800            |  |                              | 18.40 |                | 800   |                              |   | 12.50
|Exercised                                                      |  |               |  |                              |      |                |      |                              |   |     
|Forfeited                                                      |  |               |  |                              |      |                |      |                              |   |     
|                                                               |  |                |  |                              |       |                |       |                              |   |      
|Outstanding at end of year                                     |  | 5,500          |  | $                            | 14.20 |                | 4,700 |                              | $ | 13.49
|                                                               |  |                |  |                              |       |                |       |                              |   |      
|Options exercisable at year-end                                |  | 4,700          |  | $                            | 13.49 |                | 3,900 |                              | $ | 13.69
|                                                               |  |                |  |                              |       |                |       |                              |   |      
|Weighted-average fair value of options granted during the year |  |                |  | $                            | 3.92  |                |       |                              | $ | 1.74 



Information pertaining to options
outstanding at December 31, 2004 is as follows:



|                           |  |                     |  |                                         |  |                   |  |                                        
|-------------------------- |  | ------------------- |  | --------------------------------------- |  | ----------------- |  | ---------------------------------------
|                           |  | Options Outstanding |  | Options Exercisable                    
|Exercise Price             |  | NumberOutstanding   |  | WeightedAverageRemainingContractualLife |  | NumberExercisable |  | WeightedAverageRemainingContractualLife
|$18.00                     |  | 700                 |  | 3.5 years                               |  | 700               |  | 3.5 years                              
|12.75                      |  | 3,200               |  | 6.0                                     |  | 3,200             |  | 6.0                                    
|12.50                      |  | 800                 |  | 8.5                                     |  | 800               |  | 8.5                                    
|18.40                      |  | 800                 |  | 9.5                                     |  |                  |  |                                       
|                           |  |                     |  |                                         |  |                   |  |                                        
|Outstanding at end of year |  | 5,500               |  | 6.9                                     |  | 4,700             |  | 6.0                                    
|                           |  |                     |  |                                         |  |                   |  |                                        



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 16 EARNINGS PER SHARE



The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares diluted potential
common stock. Potential dilutive common stock had no effect on income available to common shareholders.



|                               |  |           |  |                |      |        |           |                |   |     
|------------------------------ |  | --------- |  | -------------- | ---- | ------ | --------- | -------------- | - | ----
|                               |  | 2004      |  | 2003          
|                               |  | Shares    |  | PerShareAmount |      | Shares |           | PerShareAmount
|Basic earnings per share       |  | 1,073,435 |  | $              | 1.46 |        | 1,091,742 |                | $ | 1.20
|                               |  |           |  |                |      |        |           |                |   |     
|Effect of dilutive securities: |  |           |  |                |      |        |           |                |   |     
|Stock Options                  |  | 1,081     |  |                |      |        | 326       |                |   |     
|                               |  |           |  |                |      |        |           |                |   |     
|Diluted earnings per share     |  | 1,074,516 |  | $              | 1.45 |        | 1,092,068 |                | $ | 1.20
|                               |  |           |  |                |      |        |           |                |   |     



As of December 31, 2004, stock options
representing 1,300 average shares were not included in computing diluted EPS because their effects were anti-dilutive.



NOTE 17 OFF-BALANCE SHEET COMMITMENTS:



The contract or notional amount of financial instruments at December 31, with off-balance sheet risk are as follows:



|                                                                 |  |                |       |      |   |      
|---------------------------------------------------------------- |  | -------------- | ----- | ---- | - | -----
|                                                                 |  | 2004           |       | 2003
|                                                                 |  | (In Thousands)
|Unfunded lines of credit (commercial and personal)               |  | $              | 2,920 |      | $ | 2,715
|Loan commitments and letters of credit (commercial and personal) |  |                | 2,425 |      |   | 1,369
|Credit card unused credit limits                                 |  |                | 1,909 |      |   | 2,302



Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The bank evaluates each customers credit worthiness on a case-by-case basis. The amount of
collateral obtained, if it is deemed necessary by the Bank, is based on managements credit evaluation of the counter-party.



Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit
to existing customers. These lines of credit generally are un-collateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Bank is committed.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 17 OFF-BALANCE SHEET COMMITMENTS (Continued):



Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of
credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments for which collateral is deemed necessary.



NOTE 18 TRANSACTIONS WITH RELATED PARTIES:



During the year, officers and directors (and companies controlled by them) were customers of and had transactions with the Company in the normal course of business. These
transactions were made on substantially the same terms as those prevailing for other customers and did not involve any abnormal risk. Loan transactions to such related parties are shown in the following schedule:



|                               |  |                |      |   |      |   |     |  
|------------------------------ |  | -------------- | ---- | - | ---- | - | --- | -
|                               |  | 2004           |      |   | 2003 |  
|                               |  | (In Thousands) |     
|Total loans, beginning of year |  | $              | 821  |   |      | $ | 685 |  
|New loans                      |  |                |     |   |      |   | 207 |  
|Payments                       |  |                | (111 | ) |      |   | (71 | )
|                               |  |                |      |   |      |   |     |  
|Total Loans, End of Year       |  | $              | 710  |   |      | $ | 821 |  
|                               |  |                |      |   |      |   |     |  



NOTE 19 DISCLOSURES ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS:



Statement of Financial Accounting
Standards No. 107 (SFAS 107) Disclosures About the Fair Value of Financial Statements defines the fair value of a financial instrument as the amount at which a financial instrument could be exchanged in a current transaction between
willing parties, other than in a forced liquidation sale. As the majority of the Companys financial instruments lack an available trading market, significant estimates, assumptions and present value calculations are required to determine
estimated fair value.



The following methods and assumptions were used to
estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:



Cash and Short-Term Investments - For those short-term instruments, the carrying amount is a reasonable estimate of fair value.



Securities  Fair values, excluding restricted stock, are based on quoted market
prices or dealer quotes. The carrying value of the restricted stock approximates fair value based on each issuers redemption provision.



Loans Receivable  For certain homogeneous categories of loans, such as some residential mortgages, and other consumer loans, fair value is estimated using
the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar
loans would be made to borrowers with similar credit ratings and for the same remaining maturities.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 19 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued):



Deposits and Borrowings  The fair value of demand deposits, savings accounts, and certain money market deposits is the amount
payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value of all other deposits and borrowings is
determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.



Accrued Interest  The carrying amounts of accrued interest approximate fair value.



Off-Balance-Sheet Financial Instruments  The fair value of commitments to extend credit is estimated using the fees currently
charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter party. For fixed-rate loan commitments, fair value also considers the difference between current levels
of interest rates and the committed rates.



The fair value of stand-by letters
of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date.



At December 31, 2004 and 2003, the fair value of loan commitments and stand-by letters of
credit were immaterial.



Estimated fair value and the carrying value of
financial instruments at December 31, 2004 and 2003 are as follows (in thousands):



|                              |  |                     |        |               |   |                     |  |               |        |  |   |       
|----------------------------- |  | ------------------- | ------ | ------------- | - | ------------------- |  | ------------- | ------ |  | - | ------
|                              |  | 2004                |        | 2003         
|                              |  | EstimatedFair Value |        | CarryingValue |   | EstimatedFair Value |  | CarryingValue
|                              |  | (In Thousands)     
|Financial Assets              |  |                     |        |               |   |                     |  |               |        |  |   |       
|Cash                          |  | $                   | 9,896  |               | $ | 9,896               |  | $             | 7,579  |  | $ | 7579  
|Interest bearing deposits     |  |                     | 10,480 |               |   | 10,480              |  |               | 5,212  |  |   | 5,212 
|Federal funds sold            |  |                     | 950    |               |   | 950                 |  |               | 2,500  |  |   | 2,500 
|Securities available for sale |  |                     | 12,331 |               |   | 12,331              |  |               | 18,348 |  |   | 18,348
|Securities held to maturity   |  |                     | 16     |               |   | 16                  |  |               | 33     |  |   | 31    
|Loans, net                    |  |                     | 97,793 |               |   | 92,283              |  |               | 86,039 |  |   | 80,781
|Accrued interest receivable   |  |                     | 491    |               |   | 491                 |  |               | 497    |  |   | 497   
|                              |  |                     |        |              
|Financial Liabilities         |  |                     |        |               |   |                     |  |               |        |  |   |       
|Demand Deposits:              |  |                     |        |               |   |                     |  |               |        |  |   |       
|Non-interest bearing          |  |                     | 26,194 |               |   | 26,194              |  |               | 21,181 |  |   | 21,181
|Interest bearing              |  |                     | 14,890 |               |   | 14,890              |  |               | 14,155 |  |   | 14,155
|Savings deposits              |  |                     | 13,954 |               |   | 13,954              |  |               | 12,888 |  |   | 12,888
|Time deposits                 |  |                     | 45,979 |               |   | 45,759              |  |               | 52,442 |  |   | 51,367
|Long-term debt                |  |                     | 18,314 |               |   | 18,300              |  |               | 7,425  |  |   | 7,425 
|Accrued interest payable      |  |                     | 253    |               |   | 253                 |  |               | 317    |  |   | 317   



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 20 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued):



The Company, through its bank subsidiary, assumes interest rate risk (the risk that general interest rate levels will change) as a result of
its normal operations. As a result, the fair value of their financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable. Management attempts to match maturities of assets and liabilities
to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to repay in a rising rate environment and more likely to repay in a falling rate environment. Management monitors rates
and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Companys overall interest rate risk.



NOTE 21 EMPLOYEE BENEFIT PLANS



The Bank has a 401(k) Profit Sharing Plan covering full-time employees who have completed
180 days of service and are at least 21 years of age. Employees may contribute compensation subject to certain limits based on federal tax laws. The Bank makes discretionary matching contributions equal to 100 percent of an employees
compensation contributed to the Plan up to 3 percent of the employees compensation. Additional amounts may be contributed, at the option of the Banks Board of Directors. Employer contributions vest to the employee over a six-year period,
and employees become 100% vested in his/her seventh year of full-time employment. For the years ended December 31, 2004 and 2003, total expense attributable to this plan amounted to $36,949 and $31,351, respectively.



The Companys Employee Stock Ownership Plan (ESOP), which held 65,018 or 6.06% of
outstanding shares of common stock, was terminated and dissolved effective December 30, 2004. The termination of this plan gave participants certain rights and elections for benefits to be paid either in cash or stock. The termination of the ESOP
plan resulted in the retirement of 39,605 shares of stock at a value of $15.47 per share or $613,000 as of December 31, 2004. The funding for the retirement of these shares and related payouts to the plan participants was taken from capital reserves
in the form of a dividend from the subsidiary to the holding company. Benefit participants who chose to retain their shares of stock under this termination will have certain put options which may require the Company to repurchase and retire these
shares at a future date yet to be determined, as described in the plan agreement at the stocks latest appraised fair market value for ESOP purposes. The estimated potential aggregate payout for future put options, if exercised with the current
per share valuation remaining the same, would be approximately $393,000. Shares retired in the future based on a higher valuation would increase the payout accordingly.



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS:



BALANCE SHEETS

December 31, 2004 and 2003



|                                            |  |                |        |      |   |       
|------------------------------------------- |  | -------------- | ------ | ---- | - | ------
|                                            |  | 2004           |        | 2003
|                                            |  | (In Thousands)
|ASSETS                                      |  |                |        |      |   |       
|                                            |  |               
|Cash and cash equivalents                   |  | $              | 491    |      | $ | 161   
|Investment in subsidiary                    |  |                | 10,384 |      |   | 10,619
|Securities available for sale               |  |                | 2,024  |      |   | 1,689 
|Bank premises and equipment, net            |  |                | 737    |      |   | 773   
|                                            |  |                |        |      |   |       
|Total Assets                                |  | $              | 13,636 |      | $ | 13,242
|                                            |  |                |        |      |   |       
|LIABILITIES                                 |  |                |        |      |   |       
|                                            |  |               
|Deferred income taxes                       |  | $              | 93     |      | $ | 4     
|Income tax payable                          |  |                | 6      |      |   | 10    
|Due to subsidiaries                         |  |                |       |      |   | 63    
|                                            |  |                |        |      |   |       
|Total Liabilities                           |  |                | 99     |      |   | 77    
|                                            |  |                |        |      |   |       
|STOCKHOLDERS EQUITY                        |  |                |        |      |   |       
|                                            |  |               
|Common stock                                |  |                | 517    |      |   | 537   
|Retained earnings                           |  |                | 12,918 |      |   | 12,464
|Accumulated other comprehensive income, net |  |                | 102    |      |   | 164   
|                                            |  |                |        |      |   |       
|Total Stockholders Equity                  |  |                | 13,537 |      |   | 13,165
|                                            |  |                |        |      |   |       
|Total Liabilities and Stockholders Equity  |  | $              | 13,636 |      | $ | 13,242
|                                            |  |                |        |      |   |       



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (Continued):



STATEMENTS OF INCOME

Years Ended December
31, 2004 and 2003



|                                                                                                   |  |                |       |   |      |   |      
|-------------------------------------------------------------------------------------------------- |  | -------------- | ----- | - | ---- | - | -----
|                                                                                                   |  | 2004           |       |   | 2003
|                                                                                                   |  | (In Thousands)
|INCOME                                                                                             |  |                |       |   |      |   |      
|                                                                                                   |  |               
|Dividends from subsidiary                                                                          |  | $              | 1,565 |   |      | $ | 483  
|Interest income                                                                                    |  |                | 1     |   |      |   | 1    
|Dividend income                                                                                    |  |                | 35    |   |      |   | 47   
|Security gains                                                                                     |  |                | 174   |   |      |   | 116  
|Rent income                                                                                        |  |                | 83    |   |      |   | 83   
|Other income                                                                                       |  |                | 4     |   |      |   | 78   
|                                                                                                   |  |                |       |   |      |   |      
|Total Income                                                                                       |  |                | 1,862 |   |      |   | 808  
|                                                                                                   |  |                |       |   |      |   |      
|EXPENSES                                                                                           |  |                |       |   |      |   |      
|                                                                                                   |  |               
|Occupancy expenses                                                                                 |  |                | 37    |   |      |   | 37   
|Equipment expense                                                                                  |  |                | 14    |   |      |   | 14   
|Other operating expenses                                                                           |  |                | 74    |   |      |   | 100  
|                                                                                                   |  |                |       |   |      |   |      
|Total Expenses                                                                                     |  |                | 125   |   |      |   | 151  
|                                                                                                   |  |                |       |   |      |   |      
|Net income before income tax expense and increase (decrease) in undistributed equity of affiliates |  |                | 1,737 |   |      |   | 657  
|                                                                                                   |  |               
|INCOME TAX EXPENSE                                                                                 |  |                | 56    |   |      |   | 50   
|                                                                                                   |  |                |       |   |      |   |      
|Net income before increase (decrease) in undistributed income of affiliates                        |  |                | 1,681 |   |      |   | 607  
|                                                                                                   |  |               
|Increase (decrease) in undistributed income of subsidiary                                          |  |                | (119  | ) |      |   | 707  
|                                                                                                   |  |                |       |   |      |   |      
|NET INCOME                                                                                         |  | $              | 1,562 |   |      | $ | 1,314
|                                                                                                   |  |                |       |   |      |   |      



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PIONEER BANKSHARES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 22 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (Continued):



STATEMENTS OF CASH FLOWS

Years Ended
December 31, 2004 and 2003



|                                                                                  |  |                |        |   |      |   |        |  
|--------------------------------------------------------------------------------- |  | -------------- | ------ | - | ---- | - | ------ | -
|                                                                                  |  | 2004           |        |   | 2003 |  
|                                                                                  |  | (In Thousands) |       
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                |        |   |      |   |        |  
|Net income                                                                        |  | $              | 1,562  |   |      | $ | 1,314  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                |        |   |      |   |        |  
|Undistributed subsidiary income                                                   |  |                | 119    |   |      |   | (707   | )
|(Gain) on security sales                                                          |  |                | (174   | ) |      |   | (116   | )
|Depreciation                                                                      |  |                | 36     |   |      |   | 38     |  
|Net change in:                                                                    |  |                |        |   |      |   |        |  
|Other receivables                                                                 |  |                |       |   |      |   | 157    |  
|Accrued expenses                                                                  |  |                | (11    | ) |      |   | (103   | )
|                                                                                  |  |                |        |   |      |   |        |  
|Net Cash Provided by Operating Activities                                         |  |                | 1,532  |   |      |   | 583    |  
|                                                                                  |  |                |        |   |      |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                |        |   |      |   |        |  
|Proceeds from sales of securities available for sale                              |  |                | 2,105  |   |      |   | 1,805  |  
|Purchase of securities available for sale                                         |  |                | (2,179 | ) |      |   | (1,863 | )
|                                                                                  |  |                |        |   |      |   |        |  
|Net Cash Used in Investing Activities                                             |  |                | (74    | ) |      |   | (58    | )
|                                                                                  |  |                |        |   |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |                |        |   |      |   |        |  
|Purchase and subsequent retirement of common stock                                |  |                | (613   | ) |      |   |       |  
|Dividends paid                                                                    |  |                | (515   | ) |      |   | (546   | )
|                                                                                  |  |                |        |   |      |   |        |  
|Net Cash Used in Financing Activities                                             |  |                | (1,128 | ) |      |   | (546   | )
|                                                                                  |  |                |        |   |      |   |        |  
|Net Increase (decrease) in Cash and Cash Equivalents                              |  |                | 330    |   |      |   | (21    | )
|                                                                                  |  |               
|Cash and Cash Equivalents, Beginning of Year                                      |  |                | 161    |   |      |   | 182    |  
|                                                                                  |  |                |        |   |      |   |        |  
|Cash and Cash Equivalents, End of Year                                            |  | $              | 491    |   |      | $ | 161    |  
|                                                                                  |  |                |        |   |      |   |        |  



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Item 8. Changes I and Disagreements with Accountants On Accounting and Financial Disclosure.



NOT APPLICABLE



Item 8A. Controls and Procedures.



As a result of the enactment of the Sarbanes-Oxley Act of 2002, issuers such as Pioneer Bankshares, Inc. that file periodic reports under the Securities Exchange Act of 1934 (the Act) are required to include in those reports
certain information concerning the issuers controls and procedures for complying with the disclosure requirements of the federal securities laws. These disclosure controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by an issuer in the reports it files or submits under the Act, is communicated to the issuers management, including its principal executive officer or officers and principal
financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.



We have established disclosure controls and procedures to ensure that material information related to the Company is made known to our principal executive
officers and principal financial officer on a regular basis, in particular during the periods in which our quarterly and annual reports are being prepared. As required, we evaluate the effectiveness of these disclosure controls and procedures on a
quarterly basis, and have done so as of the end of the period covered by this report. There have been no changes in the Companys internal control over financial reporting during the three months ended December 31, 2004, that has materially
affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. There were no significant changes in the Companys internal controls pertaining to its financial reporting and control of its
assets or in other factors that could significantly affect these controls since the date of their evaluation.



Item 8B. Other Information.



Not Applicable



Part III



Item 9. Directors, Executive Officers Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.



All required information on the directors of the Company is detailed in the Companys 2005 definitive proxy statement for the annual meeting of
shareholders (Definitive Proxy Statement), which is expected to be filed with the Securities and Exchange Commission within the required time period, and is incorporated herein by reference. The following provides information on
Executive Officers who are not directors of the Company and are not included in the Proxy Statement:



|                  |  |     |  |                                                             
|----------------- |  | --- |  | ------------------------------------------------------------
|Executive Officer |  | Age |  | Principal Occupation During Past Five
Years                 
|Betty J. Purdham  |  | 56  |  | Senior Vice President/ Chief Lending Officer, Pioneer Bank. 
|                  |  |    
|Judy L. Painter   |  | 55  |  | Senior Vice President/ Administration Officer, Pioneer Bank.
|                  |  |    
|Lori G. Hassett   |  | 38  |  | Vice President / Chief Financial Officer/ Pioneer Bank      



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##### Table of Contents

Item 10. Executive Compensation.



Information on
executive compensation is provided in the Definitive Proxy Statement and is incorporated herein by reference.



Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.



Information on security ownership of certain beneficial owners and management is provided in the Definitive Proxy Statement, and is incorporated herein by reference.



Equity Compensations Plan Information.



The following table sets forth information as of December 31, 2004 with
respect to certain compensation plans under which equity securities of the Company are authorized for issuance.



|                                                           |  |                                                                                              |  |                                                                             |       |                                                                                                                                           |             
|---------------------------------------------------------- |  | -------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------- | ----- | ----------------------------------------------------------------------------------------------------------------------------------------- | ------------
|                                                           |  | Number ofSecurities to beissued upon exercise ofoutstanding options,warrants, and rights (a) |  | Weighted-average exerciseprice ofoutstandingoptions,warrants,
andrights (b) |       | Number of securitiesremaining availablefor future issuanceunder
equitycompensation plans(excluding securitiesreflected in column (a)) (c)
|Equity Compensation plans approved by security holders     |  | 5,500 shares                                                                                 |  | $                                                                           | 14.20 |                                                                                                                                           | 8,500 shares
|Equity Compensation plans not approved by security holders |  |                                                                                              |  |                                                                             |       |                                                                                                                                           |             
|Total                                                      |  | 5,500 shares                                                                                 |  | $                                                                           | 14.20 |                                                                                                                                           | 8,500 shares



Item 12. Certain Relationships and Related Transactions.



Information on certain relationships and related transactions are detailed in the Definitive Proxy Statement, and is incorporated herein by reference.



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##### Table of Contents

Item 13. Exhibits



The following exhibits are
filed as part of this Form 10-KSB and this list includes the Exhibit Index.



|     |  |                                                                                                                                                                                                                           
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  |  | Articles of Incorporation of Pioneer Bankshares, Inc. (incorporated by reference to Exhibit 3.1 of Pioneer Bankshares, Inc.s Form 10-SB filed May 2, 2000, as amended).                                                  
|     | 
|3.2  |  | Bylaws of Pioneer Bankshares, Inc. (incorporated by reference to Exhibit 3.2 of Pioneer Bankshares, Inc.s Form 10-SB filed May 2, 2000, as amended).                                                                     
|     | 
|10.1 |  | Pioneer Bankshares, Inc. (Formerly Page Bankshares, Inc.), 1998 Stock Incentive Plan (incorporated by reference to Exhibit A of Pioneer Bankshares, Inc.s Form 10-QSB filed August 12,
2002).                            
|     | 
|21   |  | List of subsidiaries.                                                                                                                                                                                                     
|     | 
|23.1 |  | Consent of Yount, Hyde & Barbour, P.C.                                                                                                                                                                                    
|     | 
|31.1 |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (filed herewith).                                                                                                                                     
|     | 
|31.2 |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) (filed herewith).                                                                                                                                     
|     | 
|32   |  | Certifications of Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (filed herewith).



Item 14. Principal Accountant Fees and Services.



Information on principal accountant fees and services is provided in the Definitive Proxy Statement and is incorporated herein by reference.



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##### Table of Contents

SIGNATURES



In accordance with Section 13 or 15(d)
of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|              |  |                          |  |                                           
|------------- |  | ------------------------ |  | ------------------------------------------
|              |  | Pioneer Bankshares, Inc.
|              |  |                         
|              |  | By:                      |  | /s/ THOMAS R. ROSAZZA                     
|Date: 3/29/05 |  |                          |  | Thomas R. Rosazza                         
|              |  |                          |  | President and Chief Executive Officer     
|              |  |                         
|Date: 3/29/05 |  | By:                      |  | /s/ LORI G. HASSETT                       
|              |  |                          |  | Lori G. Hassett                           
|              |  |                          |  | Vice President and Chief Financial Officer



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SIGNATURE



In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date
indicated.



|                                           |  |                                                 |  |        
|------------------------------------------ |  | ----------------------------------------------- |  | -------
|Signature                                  |  | Title                                           |  | Date   
|/s/ ROBERT E. LONGRobert E. Long           |  | Director                                        |  | 3/22/05
|                                           |  |                                                
|/s/ KYLE MILLERKyle Miller                 |  | Director                                        |  | 3/24/05
|                                           |  |                                                
|/s/ PATRICIA G. BAKERPatricia G. Baker     |  | Director                                        |  | 3/17/05
|                                           |  |                                                
|/s/ DAVID N. SLYEDavid N. Slye             |  | Director                                        |  | 3/24/05
|                                           |  |                                                
|/s/ HARRY F. LOUDERBACKHarry F. Louderback |  | Director                                        |  | 3/24/05
|                                           |  |                                                
|/s/ LOUIS L. BOSLEYLouis L. Bosley         |  | Director                                        |  | 3/24/05
|                                           |  |                                                
|/s/ MARK N. REEDMark N. Reed               |  | Director                                        |  | 3/23/05
|                                           |  |                                                
|/s/ E. POWELL MARKOWITZE. Powell Markowitz |  | Director                                        |  | 3/24/05
|                                           |  |                                                
|/s/ THOMAS R. ROSAZZAThomas R. Rosazza     |  | President, Chief Executive Officer and Director |  | 3/29/05
|                                           |  |                                                
|/s/ LORI G. HASSETTLori G. Hassett         |  | Vice President, Chief Financial Officer         |  | 3/29/05



61